- From a monetary policy perspective, China is in a different place as compared to the rest of the world. It is likely to keep an easy monetary policy in order to stabilise the economy, which would bode well for the prices of Chinese government bonds (CGBs).
- Unlike the US, China’s inflation remains manageable. CGBs are offering higher as well as positive real yields, which is rare to find in most major economies these days.
- Historically, CGBs have shown low correlation with global peers as their performance is mainly driven by domestic factors. This provides investors with diversification benefits.
- The ICBC CSOP FTSE Chinese Government Bond Index ETF (SGX:CYC) provides investors with a pure-play exposure to CGBs. In comparison to peers, the ETF comes with a lower expense ratio, and also stacks up well in terms of other measures such as liquidity.
In previous articles, we highlighted the attractiveness of Chinese government bonds (CGBs) – namely, decent yields and low correlation with global bonds.
(Related article: Chinese government bonds are a good fixed income diversifier)
Unsurprisingly, CGBs have proven to be reliable safe haven assets amidst the volatility in global bonds. CGBs, as gauged by the FTSE China Government Bond Index, had gained 7.3% over the past year (in USD terms on a total return basis). It outperformed the Bloomberg Global Aggregate Index, representing a basket of investment grade debt around the world, which lost -6.6% during the same period.
Figure 1: 1-year performance comparison of CGBs and global peers
Looking ahead, global bonds will continue to face near-term headwinds due to a tightening of monetary policies across major economies. However, from a monetary policy perspective, China is in a different place as compared to the rest of the world. Therefore, amidst this global interest rate environment, we believe that CGBs provide an area of opportunity.
A tale of two central banks
China tends to operate in its own distinct way. Unlike many global peers, the People’s Bank of China (PBOC) has maintained an accommodative monetary policy over the past year.
In January 2022, the PBOC cut its key lending rates – a first since April 2020 (i.e. the peak of the pandemic) – amidst concerns about an economic slowdown, dragged by a property market downturn and a strict zero-COVID policy.
Moving forward, all eyes will be on the 20th Party Congress, which is the main political event of the year. Due to be held in late 2022, the 20th Party Congress is responsible for formally approving the membership of the Central Committee. This will also determine whether President Xi Jinping continues for another presidential term.
With weakening economic growth in face of multiple headwinds, China is likely to roll out more policy measures in order to stabilise the economy before the 20th Party Congress. Hence, we believe that there is a strong case to be made for the PBOC to keep an easy monetary policy.
We expect an increasingly divergent monetary policy between US and China for the rest of this year. The US Federal Reserve is expected to start raising interest rates from near zero to curb persistent inflation. Meanwhile, the PBOC could continue easing in the first half of 2022 to support its slowing economy. This could lead to more rate cuts which may bode well for CGBs’ prices.
Yield remains attractive relative to developed market bonds
Currently, the yield spread of CGBs over US Treasuries has narrowed to 75 basis points (bps) as shown in Figure 2 below. The yield advantage that CGBs have over USTs is likely to erode further as the US treasury curve gradually steepens.
Figure 2: Yield spread has narrowed
Nonetheless, we believe that investors should consider what CGBs can bring to the table from a real yield perspective. Real yield, which takes into account inflation, matters especially during periods of high inflation expectations.
Unlike the US, China’s inflation remains manageable (Figure 3). Inflationary pressures in China have been easing thanks to falling food and commodity costs. Based on the latest December 2021 data, China’s consumer price index (CPI) grew 1.5% year-on-year, moderating from the previous month’s increase of 2.3%. Meanwhile, US inflation levels has hit its fastest pace in nearly four decades, with the CPI climbing by 7.5% in January 2022.
Figure 3: Inflation in China is currently far lower than that in the US
The inflation forecast in 2022 for China stands at 2.2%, while that for the US is forecasted to stay elevated at 4.8%. Currently, CGBs have a nominal yield of 2.78%. After adjusting for inflation, CGBs offer a real yield of 0.58%, which is approximately 335 bps above that of US Treasuries. We believe it is worth highlighting that CGBs offer positive real yield, which is now rare to find in most major economies (Figure 4).
Figure 4: Comparison of real yields with developed market bonds
On top of that, it is also worth noting that China has a sovereign credit rating of A+ by Standard & Poor’s, which is comparable to that of certain developed economies. While other large Asian economies, such as Indonesia and India, do offer higher real yields of 3.5% and 1.4% respectively, investors should note that they come alongside a higher level of credit risk.
A good fixed income diversifier
Besides relatively higher real yields, there is one more good reason as to why investors should not overlook CGBs. Historically, CGBs have shown low correlation with global peers (Table 1). This enables them to provide diversification benefits, which is why we believe that CGBs deserve a place in a global diversified portfolio.
Table 1: Correlation of global bonds
|
|
CGB |
Global Aggregate |
US Govt |
Euro Govt |
UK Govt |
Japan Govt |
EM LC Govt |
|
CGB |
1.00 |
|
|
|
|
|
|
|
Global Aggregrate |
0.21 |
1.00 |
|
|
|
|
|
|
US Govt |
0.16 |
1.03 |
1.00 |
|
|
|
|
|
Euro Govt |
0.10 |
0.45 |
0.23 |
1.00 |
|
|
|
|
UK Govt |
0.10 |
0.36 |
0.19 |
0.60 |
1.00 |
|
|
|
Japan Govt |
0.11 |
0.63 |
0.82 |
0.53 |
0.39 |
1.00 |
|
|
EM LC Govt |
0.13 |
0.37 |
0.32 |
0.70 |
0.41 |
0.03 |
1.00 |
|
From Jan 2008 to Feb 2022. Source: Bloomberg Finance L.P., iFAST Compilations. CGB: FTSE Chinese GBI USD; Global Aggregate: Bloomberg Global Aggregate USD Unhedged Index; US Govt: FTSE US GBI LCL; Euro Govt: FTSE EMU GBI USD; UK Govt: FTSE UK GBI USD; Japanese Govt: FTSE Japan GBI; EM LCY Govt: Bloomberg EM Local Currency Government USD Unhedged Index. |
|||||||
The low correlation between CGBs and global peers is largely attributed to the fact that the performance of CGBs is mainly driven by domestic factors. Such domestic factors include the interest rate movements in China, which is vastly different from the rest of the world.
Correlation is also partly driven by the foreign holdings of CGBs. Over the years, due to developments in China’s onshore bond market, the foreign holdings of CGBs have increased. Most recently, CGBs have been included into the FTSE Russell World Government Bond Index, sending inflows into the market.
As China’s economy matures and with its financial markets opening up, foreign holdings is likely to increase. Moving forward, CGBs’ correlation with global bonds is likely to rise in tandem with increasing foreign investor participation. However, given China’s independent monetary policy, we believe the correlation is likely to remain below that of major developed bond markets.
ICBC CSOP FTSE Chinese Government Bond Index ETF (SGX:CYC)
Investors seeking a pure-play exposure to CGBs can consider our recommended ETF, the ICBC CSOP FTSE Chinese Government Bond Index ETF (SGX:CYC). The ETF tracks the FTSE Chinese Government Bond Index, comprising of fixed-rated government bonds issued in mainland China.
In comparison to other ETFs, the ICBC CSOP FTSE Chinese Government Bond Index ETF (SGX:CYC) comes with a lower expense ratio. It also stacks up well against its peers in terms of other measures such as liquidity and assets under management (AUM).
Table 2: Comparison of SGX:CYC with peers
|
Name of ETF |
Expense Ratio (%) |
Average Daily Volume |
AUM (CNY billions) |
Yield (%) |
|
ICBC CSOP FTSE Chinese Govt Bond Index ETF (SGX:CYC) |
0.25 |
63,600 |
9.30 |
2.75 |
|
CSOP Bloomberg Barclays China Treasury + Policy Bank Bond Index ETF (HKEX:3199) |
0.28 |
11,200 |
5.29 |
3.28 |
|
NikkoAM-ICBCSG China Bond ETF (SGX:ZHS) |
0.30 |
59,200 |
1.49 |
2.97 |
|
ChinaAMC Bloomberg Barclays China Treasury + Policy Bank Bond Index ETF (HKEX:2813) |
0.85 |
418.2 |
0.02 |
3.28 |
|
Source: Bloomberg Finance L.P., iFAST Compilations Data as of 10 February 2022 |
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Overall, CGBs is a fixed income segment not to be ignored. The easing of monetary policy in China is likely to bode well for the prices of CGBs. Additionally, the yield of CGBs are likely remain attractive relative to developed bond markets. Coupled with the low correlation with global bonds, we believe investors stand to benefit from an allocation to CGBs in their portfolios.
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