Asian bonds are back in vogue
After several steps by the authorities in recent years to open up China’s financial markets to foreign investors, Chinese bonds have increasingly been included in international fixed-income indexes. Coupled with relatively stronger economic growth and higher interest rates than in developed markets, moves towards the internationalisation of the renminbi may further increase the attractiveness of financial assets in that currency, including bonds.
Foreign investors in onshore Chinese bonds face some risks. Capital controls generally remain in place for domestic companies, households and foreigners. However, we would assign a low probability to the risk that China reinstates strict capital controls for foreign investors in the event of a sharp depreciation of its currency given that the Chinese want to increase policy credibility. With quotas and special registration requirements, access to China’s onshore financial markets remains restricted to institutional investors for now.
Despite the risks and constraints, we continue to see Chinese sovereign bonds in renminbi as offering an attractive investment opportunity thanks to the prospect for further renminbi appreciation and some further tightening of the Chinese-US bond yield spread. Indeed, moderate Chinese inflation and increased investor inflows could lead to a fall in long-term Chinese sovereign yields.
Since spreads reached a peak in early July, Chinese government bonds have performed better than US Treasuries, even more so once converted into US dollars. We expect investors will continue to pile into Chinese bonds, attracted both by the yield differential and the potential for further renminbi appreciation on the back of China’s economic resilience.
This resilience also offers opportunities in Chinese credit. US dollar (USD) liquidity has improved thanks to the US Federal Reserve’s quantitative easing and the putting in place of US dollar swap lines with some of the main Asian central banks. This has made the Asian USD corporate default rate manageable (3.8% on October), while Asia investment grade (IG) spreads continue to offer an attractive premium over their US and euro area equivalents. Given the comfortable spread cushion they offer, we continue to prefer Asian IG bonds to high-yield ones. Joe Biden's presidential victory in the US may prove a further catalyst for this asset class.