Foreign investors are more upbeat on the outlook for China’s recovery than those actually based in the world’s second-biggest economy — at least if bond-market pricing is anything to go by.
(Bloomberg) — Foreign investors are more upbeat on the outlook for China’s recovery than those actually based in the world’s second-biggest economy — at least if bond-market pricing is anything to go by.
Rates on non-deliverable swaps — instruments that are settled in US dollars and more likely to be used by non-resident investors — are notably higher than the yields offered by Chinese government bonds, a market dominated by locals. For instruments with a five-year maturity, the gap between non-deliverable swap rates and bond yields widened toward 27 basis points earlier in March, a level last seen in 2018.
All else being equal, that suggests that foreigners are looking for higher fixed-income rates, a situation that tends to go hand-in-hand with tighter monetary policy and stronger growth. And it appears very much to be a shift by foreigners that’s driving much of the divergence, with the rate on the five-year swap climbing to the highest since December 2019 just before the National People’s Congress earlier this month.
It’s an indication that offshore investors see China’s economic recovery as solidly on track, which will cap further monetary easing out of Beijing and lead to higher fixed-income yields. Onshore traders, meanwhile, appear to be adopting a more wait-and-see approach, with yields in the bond market much more confined.
“We assess China rates to broadly be in an upward trending range,” wrote Gaurav Garg, head of Asia foreign-exchange and rates at Citigroup Inc. in Singapore. The bank is underweight in Chinese government bonds in its model portfolio and expects the 10-year yield to gradually push toward 3.3%, from about 2.89% Wednesday.
China’s economy strengthened in the first two months of the year thanks to the end of Covid restrictions, although the recovery remains unbalanced as industrial output lagged, official data on Wednesday showed. The new leadership under President Xi Jinping has set a modest growth target of around 5% for the year at the just-concluded National People’s Congress, suggesting any big stimulus through infrastructure investment or the property market is off the table.
Optimistic growth forecasts from some prominent overseas institutions underscore some of the divergence in views. For example, Swiss bank UBS Group AG last week lifted its 2023 expansion forecast for China to 5.4% — putting it above the government’s own announced target for gross domestic product growth.
The gap between instruments favored by foreign and domestic market participants is indicative of “excessive tightening fears from offshore investors,” according to Tiffany Wang, a Hong Kong-based strategist at JPMorgan Chase & Co.
Weekly tracking data on exchange-traded funds also suggest that foreigners are wary of higher Chinese rates, pointing to debt outflows from China and Hong Kong in February and March.
The expectations that foreigners have may be based on experiences of the other major economies, where yields climbed after Covid restrictions were abandoned and economic activity picked up. But Chinese government bonds have so far acted differently despite the country’s rapid reopening. The 10-year yield has edged higher by just a few basis points over the past 12 months even in the face of foreign outflows.
Many locals, meanwhile, appear more skeptical about growth and the prospect for higher rates. Domestic institutional investors, who need to fulfill their 2023 investment mandate, are preoccupied with a “search-for-yield” mentality, according to JPMorgan. Views from onshore investors on China’s growth outlook also tend to be more pessimistic.
Yang Hao, an analyst at Nanjing Securities, said demand for Chinese bonds from local banks has held up well this year as the lenders have limited choices of higher-yielding assets at the early stages of an economic rebound. He also noted that, in the absence of forceful measures to boost the housing market, most domestic retail investors have appeared unwilling to switching their bank deposits into equities. And that has in turn helped bonds
Meanwhile, China’s real interest rate level was already “appropriate,” Yi Gang, the nation’s central bank governor said earlier this month, before his surprise reappointment to another term this past weekend.
“To many onshore investors, it just looks premature to short bonds,” said Nanjing Securities’ Yang. “So they adopted a wait-and-see strategy before the scope and sustainability of recovery gets clearer.”
(Updates with prices in the fifth paragraph and economic data in the sixth)
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