Global Funds Double China Bond Holdings as Default Starts
They increased their holdings to a record 384.1 billion yuan ($62 billion) as of Feb. 28 from 331.9 billion yuan at the end of 2013, according to data from China Central Depository & Clearing Co. and the Shanghai Clearing House. Schroder Investment Management Ltd. says renminbi debt is attractive after the currency’s 2.8 percent loss this year, Stratton Street Capital LLP is applying to enter the onshore market and Western Asset Management Co. doesn’t expect long-term depreciation.
“It has definitely become interesting at these levels to accumulate currency positions,” said Rajeev De Mello, who manages $10 billion as Singapore-based head of Asian fixed income at Schroder. He is considering adding to his yuan holdings after paring them in February.
Policy makers in the world’s second-largest economy are seeking to discourage the accumulation of debt by allowing companies to default and by introducing more volatility in exchange rates and borrowing costs. JPMorgan Chase & Co. said in a note after the central bank doubled the yuan’s daily trading limit to 2 percent on March 17 that the currency will strengthen to 5.95 per dollar by the end of this year from 6.2275 yesterday. China’s 10-year sovereign bond yield is 4.52 percent, compared with 2.77 percent for similar U.S. Treasuries. (USGG10YR)
“Yields at 4 percent and the currency’s appreciation prospects make Chinese government bonds extremely attractive compared to the nations with the same rating elsewhere in the world,” said Andy Seaman, London-based partner and fund manager at Stratton Street, which oversees $1.5 billion.
Overseas investors currently hold just 1.3 percent of the total 28.9 trillion yuan of onshore debt, with 77 percent of that either sovereign bonds or notes issued by China’s three policy banks, according to Bloomberg calculations. In the U.S., overseas buyers account for 47 percent of Treasuries.
China controls access to its domestic markets through the Qualified Foreign Institutional Investors program. As of last month, the State Administration of Foreign Exchange had approved $52.3 billion investment quotas for QFIIs, up from $40.8 billion a year earlier. The foreign-exchange regulator also approved 180.4 billion yuan in investment by Renminbi QFIIs while China Securities Regulatory Commission Chairman Xiao Gang said on March 11 that more foreign institutional investors will be allowed to enter the local market.
“As the world’s second-largest economy, and one that still has a lot of growth potential, China is significantly under allocated in global assets,” said Wang Ming, marketing director at Shanghai Yaozhi Asset Management LLP, which oversees 2 billion yuan of fixed-income investments. “Bonds are a relatively safe choice, and demand will grow as the country further opens its market, perhaps regardless of interest-rate differentials.”
The yield on China’s benchmark 10-year government bonds jumped 98 basis points last year in the biggest yearly advance in ChinaBond data going back to 2007. While the yield on the sovereign has risen eight basis points this month to 4.52 percent on March 20, the rate on the riskier AA- corporate notes has advanced 12 basis points to 8.26 percent.
The Chinese currency strengthened to a 20-year high of 6.0406 per dollar on Jan. 14, after appreciating 2.9 percent last year in the best performance in Asia. It has weakened since then as the People’s Bank of China encouraged more volatility to dissuade capital inflows driven by one-way appreciation bets on the yuan.
At least five banks cut their projections for the yuan following the band widening this week. Barclays Plc, the world’s third-largest foreign-exchange trader, cut its 12-month yuan forecast to 6.05 per dollar from 5.95. Bank of America lowered its year-end estimate to 6.10 from 6.0, implying that the currency will post its first annual decline since 2009.
Three-month implied volatility, which is used to price options, surged 84 basis points this year to 2.61 percent today, according to data compiled by Bloomberg.
“We’re slightly overweight on the yuan and most of our exposure had been hedged,” said Desmond Soon, a Singapore-based portfolio manager at Western Asset, which oversees $452 billion globally. “Long term, it’s not in the interest of Chinese authorities to create a depreciation trend for the yuan because they are trying to internationalize the currency and want to attract foreign capital into China.”
Yuan positions at Chinese financial institutions accumulated from foreign-exchange sales rose by 128.2 billion yuan in February, the smallest monthly increase since September. China’s foreign-exchange reserves climbed to a record $3.8 trillion at the end of December. Credit-default swap contracts insuring the nation’s debt against non-payment climbed to 103.5 in New York yesterday, the highest since Jan. 24, CMA prices show.
The increase in foreigners’ bond holdings is defying concern that China’s first onshore corporate default will have a spillover effect on the larger economy. Shanghai Chaori Solar Energy Science & Technology Co. (002506) became the first onshore issuer to default on March 7 when it failed to make a full coupon payment.
Chinese non-financial companies that Moody’s Investors Service rates will see little impact from the default because their exposure to any follow-on tightening in the onshore bond market is limited, the company said in a March 13 statement. Unlike more-indebted countries, China is a creditor nation and has a greater ability to repay borrowings, Stratton Street’s Seaman said.
The default is a “positive thing because it imposes credit-market discipline and it’s to prevent the build-up of moral hazard risks,” said Western Asset’s Soon.