02 June 2023
China dances to its own rhythm
Since late 2022, China has shifted from stringent Covid policies to a full-scale reopening. However, it hasn’t been the big bang that many investors were expecting. We focus on what a weaker-than-expected China growth story means for fixed income investors.
The highly anticipated reopening of China hasn’t met market expectations. Signs that growth is stumbling are already creeping into the manufacturing purchasing managers’ index (PMI), which dropped further below 50 (to 48.8 from 49.2 in April) for a second straight month and was below consensus estimates. While the non-manufacturing PMI remains in expansion territory, it is clear that PMIs across sectors have visibly moderated. In the meantime, consensus GDP growth estimates remain strong at about 5%, which is lower than earlier in the year, but not a level where we think the government would be looking to provide any stimulus. Furthermore, while many economies have experienced high levels of inflation since reopening, China appears to be the exception to the rule: its 0.1% increase in the Consumer Price Index year-over-year in April stands in stark contrast to most other regions. That said, the real estate market presents a lingering risk, given that a fall in property prices and demand has the potential to take a significant toll on the economy.
The nominal yield on the 10-year China Government Bond (CGB) remains low at 2.72% (as of 30 May 2023). This level is considerably lower than developed market equivalents, such as US Treasuries and UK Gilts, which have 10-year yields of 3.74% and 4.30%, respectively. However, given the low level of inflation in China, real yields on CGBs remain in positive territory and look attractive. Low inflation also means that the next action from the Peoples Bank of China could be to loosen monetary policy, the opposite of developed market central banks, which continue to tighten. The weakening economic data has occurred when the Chinese currency has declined to its lowest level since November vs. the US dollar, negatively impacting investors returns on existing Chinese bond investments.
Although nominal yields are higher in the US, real yields are higher in China because inflation is lower
In contrast to other fixed income markets, demand for Chinese bonds has been weak in 2023. According to our internal J.P. Morgan Asset Management flow monitor, China bond mutual funds have experienced outflows of CNY 2.37 billion year-to-date ending 30 May 2023. Additionally, investor positioning in CNY is at the shortest levels seen over the past few years. With softening domestic economic demand in China coupled with falling housing prices, we think the Chinese economy could become dependent on foreign demand. Considering these factors, it is possible that the Chinese government has stepped in to weaken the currency—albeit in the background and silently—whenever it has hit a particular upper limit. Even with currency valuations already stretched, technical impacts via government intervention could lead the currency weaker in the short term.
What does this mean for investors?
While China continues to be an important allocation to diversified fixed income portfolios, we think there are better investment opportunities over the short term. We prefer being overweight duration through Treasuries, especially in the belly of the curve, which should be less volatile in the event of a front-end sell off due to a more hawkish Federal Reserve. However, in this case, the upside potential would also be capped if rates were to rally. Within emerging markets, we find opportunities in other local currency bonds with higher real yields than CGBs and where central banks have the ability to cut rates significantly, such as Mexico.
About the Bond Bulletin
Each week J.P. Morgan Asset Management's Global Fixed Income, Currency and Commodities group reviews key issues for bond investors through the lens of its common Fundamental, Quantitative Valuation and Technical (FQT) research framework.
Our common research language based on Fundamental, Quantitative Valuation and Technical analysis provides a framework for comparing research across fixed income sectors and allows for the global integration of investment ideas.
include macroeconomic data (such as growth and inflation) as well as corporate health figures (such as default rates, earnings and leverage metrics)
is a measure of the extent to which a sector or security is rich or cheap (on both an absolute basis as well as versus history and relative to other sectors)
are primarily supply and demand dynamics (issuance and flows), as well as investor positioning and momentum