Foreign investors reverse their scenario and leave the Chinese bond market

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Substantial net capital flows out of China have officially become a trend as Chinese fixed income securities have lost their luster in favor of foreign investors.

Capital withdrawals on the Chinese interbank bond market exacerbated and continued for the third consecutive month in April. Most pundits attribute the shift to a weaker yuan and lower yield premium over similar US government bonds as China’s central bank’s monetary policy deviates from the more hawkish US stance. United.

The about-face contrasts sharply with the trend of the past few years, when yield-starved foreign investors flocked to the Chinese bond market due to extremely low yields on US debt compared to Chinese debt of the same duration, even adjusted. depending on the risk. .

For years, foreign investors have viewed Chinese government bonds as a source of relatively high fixed-income yields, while Western economies have maintained historically low borrowing rates.

Today, this long-standing dynamic has completely reversed.

Foreign investors’ holdings of Chinese interbank bonds fell dramatically. Foreign institutional investors held 3.77 trillion yuan ($567 billion) of China’s interbank bonds at the end of April, down 109 billion yuan from March, down 3%, according to official data from China. Central Depository and Clearing Co. down about 113 billion yuan in March from February.

Over the past three months, official data showed foreign investors’ holdings fell by about 300 billion yuan. The decline in holdings was widespread in government bonds as well as in strategic bank bonds.

For context, the last time before this year that foreign investors’ holdings of Chinese debt fell in consecutive months was at the end of 2018.

The US Federal Reserve has announced a 50 basis point benchmark rate hike, with more to come, as the People’s Bank of China (PBoC) considers quantitative easing measures to mitigate an ongoing economic disaster wrought by the blockages instituted under the rigid “zero-policy COVID” regime.

Today, the higher yields offered by US government bonds look relatively more attractive. Additionally, global investors must now weigh the heightened geopolitical risks of holding Chinese debt after the regime’s continued support for Russia following its invasion of Ukraine in February drew international condemnation.

Bond yields support real capital flows. In 2020, 10-year US Treasuries yielded around 0.7%, while yields on similar-duration Chinese government bonds exceeded 3%. At the end of May, 10-year government bond yields reached parity, with 10-year Chinese bonds yielding 2.82% while 10-year Treasury yields yielding slightly more at 2.86%. Factor in the higher relative default risk and geopolitical risk of holding Chinese bonds, and it’s easy to see that an investor would prefer to hold US Treasury bonds over their Chinese counterparts.

Despite economically disruptive shutdowns in many cities to contain China’s worst COVID outbreak since 2020, the PBoC has remained cautious in its economic stimulus, stopping ahead of drastic measures that could push bond yields further down.

The PBoC is keenly aware of this trend and is careful not to relax too much relative to the rest of the world, lest its actions further destabilize the Chinese economy and drive the price of the yuan even lower. Already, the divergence in monetary policies has had an impact on the foreign exchange market. The yuan has fallen about 5% against the US dollar since Jan. 1.

Some market watchers believe the main driver of foreign outflows is not rates, but geopolitics. “These outings started after February 24, when the war in Ukraine started. The longer these exits last, the clearer it becomes that markets are looking at China in a new light since Russia invaded Ukraine,” wrote Institute of International Finance chief economist Robin Brooks. in a tweet in May.

Perhaps aware of not ringing the alarm bells further, the Chinese authorities suddenly ceased to communicate certain measures related to foreign capital flows in and out of its onshore bond market.

The Chinese Currency Exchange System (CFETS) suddenly stopped reporting daily bond trading data by foreign investors after May 11. Before that day, significant net outflows of foreign capital had been reported.

The CFETS did not provide a reason for the missed data reports, further fueling speculation that CCP authorities have ceased communication so as not to fan the flames of capital outflows from foreign investors selling debt. Chinese ruler.

Either way, the move – if true – would be a huge step backwards for Beijing, which had been struggling to cultivate some semblance of free markets with transparent information flows to attract foreign investors to its national markets.

The opinions expressed in this article are the opinions of the author and do not necessarily reflect the opinions of The Epoch Times.

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Fan Yu is an expert in finance and economics and has contributed analysis on the Chinese economy since 2015.

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