(Bloomberg) — Global funds slashed their holdings of Chinese bonds by the most on record last month amid the nation’s dwindling yield advantage over the U.S. and geopolitical uncertainties posed by the war in Ukraine.
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Overseas investors offloaded a record 50 billion yuan ($7.9 billion) of Chinese sovereign debt in March, reducing their holdings to 2.43 trillion yuan, according to Bloomberg calculations based on data from the People’s Bank of China.
Foreign funds had unwound bets on China’s sovereign bonds in February at a record pace, according to data compiled from the PBOC and Chinabond. The yield spread between benchmark Chinese bonds and Treasuries has almost vanished, prompting global funds including Pacific Investment Management Co. and AllianceBernstein Holding LP to cool off on the nation’s debt.
“Investors who previously held overweight positions in China onshore bonds due to high carry, a strong currency outlook and a more dovish central bank may continue to scale back exposure to neutral in the near term as the previous advantages fade,” said Becky Liu head of China macro strategy at Standard Chartered Plc.
China’s debt posted world-beating returns in 2021 as the nation’s easy monetary stance compared with the U.S. boosted its allure as a haven. While hopes of further easing by the PBOC remain, a selloff in Treasuries on expectations of aggressive Federal Reserve rate hikes is wiping out China’s yield advantage for the first time in more than a decade.
The premium on Chinese 10-year notes over similar-tenor Treasuries is now around 10 basis points, down from more than 100 basis points in the beginning of the year. Chinese bonds have seen a combined outflow of 90 billion yuan in the last two months, according to PBOC data. Data from Chinabond for March hasn’t been released yet.
High-frequency data detected outflows on an “unprecedented” scale from Chinese stocks and debt even as investments into other emerging markets held up, according to a Institute of International Finance report late last month.
The current level of outflow from the bond market isn’t likely to trigger any reaction from the PBOC as it may spur doubts about the openness of the bond market, according to David Qu, an analyst at Bloomberg Economics. “If we see a much larger capital flight, the central bank may look at it, but it is unlikely to take any aggressive actions,” he said.
Meanwhile, Goldman Sachs Group Inc. trimmed its bond inflow forecast for China to $100 billion this year, from as much as $140 billion. “We think flows may remain soft in the next few months, given the degree of geopolitical uncertainty,” the bank’s strategists including Danny Suwanapruti wrote in a April 3 note.
However, demand could return later in the year as recent events are likely to accelerate reserve diversification into yuan assets over the medium-term, according to the note.
StanChart’s Liu also said inflows may return in the next three months on increasing usage of the yuan in trade settlements and as Beijing’s stimulus measures boost the economy.
(Adds analyst comment in fourth and seventh paragraph and details on yield spread in sixth paragraph.)
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