International money will continue to pour into Chinese fixed income markets as investors seek to capitalize on the country’s monetary easing, according to J.P. Morgan Asset Management.
In 2021, the relatively attractive yields of Chinese government bonds made China’s bond market one of the best-performing in the world. While global yields rose by 40 basis points last year, China’s 10-year government bond yields dropped 34 basis points, leading to a 6.6 percent increase in its bond prices.
“So far, this year has been a repeat given China’s easing versus global tightening,” said Gabriela Santos, global market strategist at J.P. Morgan Asset Management.
China is the only major economy swimming against the global tide of tightening monetary policies. Since January, the Federal Reserve has been signaling potential rate hikes to curb inflation in the coming months, an act that has moved the U.S. Treasury yields to a two-year high. But in China, the government has cut key rates to reduce borrowing costs, sending the 10-year bond yields to the lowest since mid 2020. Inflation is less of a concern for monetary and fiscal authorities in China as its core consumer prices only rose by 1.2 percent in 2021.
This contrarian policy stance makes Chinese fixed income more attractive because investors want to buy bonds before rates decline. By contrast, investors may view U.S. Treasuries as a risky bet because rates are expected to go up in the near future.
The low correlation between Chinese and global government bonds also offers great diversification benefits to global investors, according to JPMAM’s latest China investment outlook. Over the past 15 years, the correlation of Chinese bonds to the global bond market has stood at an average of 0.27. That compares to a global correlation of 0.9 for Germany, 0.55 for the United States, and 0.43 for India.
“China by far has the lowest correlation because the Chinese government bonds do not care what the U.S. Treasuries are doing,” Santos said. “They are going to move completely independently. What [other] countries can possibly do that?”
After a year of focusing on non-economic priorities, China will aim for a floor on growth in 2022, which explains the central bank’s decision to add support to the economy, according to Santos. In the past year, the key regulatory themes in China have been revolving around reducing inequality, leverage, and carbon emissions, all of which led to crackdowns on important players in the technology and real estate sectors. To revive an economy that’s sluggish from high regulatory pressures, the central bank will step up stimulus and focus on economic stability in the upcoming year, Santos said.
As China steps on the accelerator for the economy, investors should expect a more neutral credit impulse, she added. Credit impulse, which measures the difference between credit growth and nominal GDP growth, is a better indicator than interest rates when it comes to the Chinese debt markets because it measures both quantity and price of the bonds, according to Santos. As of December, China’s GDP growth led credit growth by 2.5 percentage points, signaling a restrictive credit cycle, according to the JPMAM report. But that cycle will likely come to an end as China unleashes liquidity to its economy.
“The credit impulse will turn at least neutral or slightly positive again,” Santos said.