Foreign investors pull back from Chinese government bonds amid market volatility

In this article Financial Times highlights that foreign investors have recently pulled back from Chinese government bonds, reversing a profitable strategy that had been encouraged by Beijing's efforts to stabilize the renminbi.

Between November of last year and August, investors had poured over $130bn into a trading strategy where they lent dollars to Chinese institutions and used the renminbi earnings to purchase Chinese bonds. This strategy offered returns of up to 6 per cent, well above the yield on US Treasury bonds. However, when Beijing announced a large stimulus package in September, it triggered a sell-off in Chinese government bonds and a rebound in the renminbi, leading to losses for investors who had invested heavily in the trade.

As a result, foreign investors sold a net Rmb275.8bn ($38bn) of Chinese debt in September and October, with the majority of the sales being government bonds, according to data from the China Central Depository & Clearing and the Shanghai Clearing House. This includes a reduction of Rmb62.8bn in holdings of interbank negotiable certificates of deposit (NCDs), a short-term government note commonly purchased by those using this strategy.

These sales marked the largest monthly outflows of NCDs on record, according to Nomura. Market movements have made “the cross-currency swap rates no longer attractive enough for foreign investors to buy NCDs,” according to Gary Ng, a senior economist at Natixis. The yield from this trade “has shrunk in recent months,” added Ju Wang, head of greater China foreign exchange and rates strategy at BNP Paribas. 

Chinese state banks had benefited from this strategy, as the currency swaps helped stabilize the renminbi’s exchange rate. However, Beijing’s stimulus package in September, which included monetary support for stock markets and debt swaps for heavily indebted local governments, led to a 0.17 per cent jump in 10-year Chinese government bond yields within just three days at the end of the month. Increased volatility in bond prices, driven by central bank interventions since August and more issuance by the Ministry of Finance, has also made these bonds less appealing to foreign investors, according to Wang.

Meanwhile, higher US Treasury yields, sparked by a recent sell-off as investors bet that a potential Donald Trump win in the US presidential election would reduce the likelihood of interest rate cuts, have made them a relatively more attractive option for investors. Longer-term demand for Chinese government bonds from foreign investors "could remain relatively light" due to a weakening renminbi, caused by a strong dollar and possible increases in US tariffs, said Xiaojia Zhi, head of Asia research at Crédit Agricole. As a result, foreign investors with a risk appetite may shift their focus to Chinese equities, Ng at Natixis suggested.

By Naila Huseynova