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China Bonds Are Still Too Big To Ignore

May 28, 2024

Read Time 4 MIN

Despite recent headwinds, China’s vast and diverse bond market is too big to exclude from long-term focused portfolios.

As China navigates a bumpy economic recovery and investor sentiment appears to be near all-time lows, we wanted to revisit the investment case for continued exposure, specifically from a fixed income perspective. In short, despite current headwinds, we believe China is too big for global bond investors to ignore, and recent headwinds are an example of how its economy stands apart from the rest of the world. Further, the onshore market, which is the second largest globally, is extremely vast and diverse, allowing investors to selectively find exposure that may help strengthen an overall global bond portfolio in the long term.

From a yield perspective, the case for China bonds has undoubtedly become less compelling following a decline of about 100 basis points (bps) since their recent high in 2020. China’s 10-year government bond yield recently hit its lowest level on record, approximately 2.2%. Further, and perhaps more importantly, the yield differential versus the U.S. hit its lowest level as well, with the 10-year bond yielding 2.4% less than its U.S. counterpart. Chinese bond yields are also well below emerging markets peers, which on average yield about 7%, based on the J.P. Morgan GBI-EM Global Diversified Index as of May 10, 2024. To be sure, China’s size and single-A credit rating make a direct comparison challenging, and its global economic standing and resources make it hard to compare against similarly rated countries like Iceland and Israel, but the trend has been clear.

China Bond Yields Have Hit a Bottom, while CNY Has Depreciated

China Bond Yields Have Hit a Bottom, while CNY Has Depreciated

Source: ICE Data Services and JP Morgan, as of 3/31/2024. Yield Pickup is represented by the difference between ICE BofA China Government Index yield and ICE BofA Developed Markets Sovereign Bond Index yield. Past performance is no guarantee of future results.

For bond investors, the yield decline over the past few years has provided significant support to returns while most global markets counterparts have struggled. The FTSE Chinese Government Bond Index returned about 1.9% per year as of April 30, 2024 since Chinese bond yields peaked in November 2020, while G-7 government bonds returned -7.8% annually. These returns include an approximate 9% depreciation of the Chinese renminbi (CNY) versus the U.S. dollar over the period. Although the CNY depreciation is notable for an historically stable currency, the currency did outperform its broader emerging markets currencies in that period.

To be sure, performance in recent years reflects structural challenges in the domestic economy that must be addressed before foreign investors return with confidence. Data has been mixed. A recent upside surprise in manufacturing PMI was promising, albeit not overwhelmingly so, while other data such as credit aggregates continue to be sluggish. Optimism on the policy front, particularly to address real estate sector concerns, and potentially renewed stimulus measures have provided hope for a more sustainable economic growth trajectory going forward, which may help to stoke foreign investor interest once again. We also note that longer term, assuming prudent policies are pursued and stable, robust growth can continue (albeit at lower levels than what was seen in previous decades), bond yields at current levels may be a reflection of China’s economic strength globally and need not rise substantially to justify a role in a diversified global bond portfolio.

Focusing on corporates, we believe there have been some positive trends. First, many troubled issuers (particularly in the real estate sector) have seen substantial declines in value or have defaulted, and therefore been removed from the index. This has resulted in a significantly lower exposure to China within the ICE Diversified High Yield US Emerging Markets Corporate Plus Index: approximately 2.2% as of May 10, 2024 versus nearly 8% four years ago. Credit spreads of onshore bonds have, in general, seen a modest decline over the past two years. With heightened caution by foreign investors following stress in corporate sectors such as real estate and certain financials, we believe reliance on global credit ratings may provide more confidence to invest in onshore corporates. The vast majority of the local corporate market relies on local ratings, which are not comparable to Western credit ratings and can cause confusion.

Although overshadowed by sluggish macroeconomic indicators, we believe the uncorrelated nature of the onshore market to the rest of the world is an important takeaway. It is worth remembering that Chinese bond yields increased following the onset of COVID-19 amid domestic economic resilience while U.S. bond yields plummeted. Over the past decade, the broad onshore Chinese bond market has exhibited a low correlation to the U.S. and global broad markets, as well as other core asset classes, and a lower correlation to these asset classes than the broad EM local currency sovereign bond market.

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Disclosures

Please note that VanEck may offer investments products that invest in the asset class(es) or industries included in this blog.

This is not an offer to buy or sell, or a recommendation to buy or sell any of the securities, financial instruments or digital assets mentioned herein. The information presented does not involve the rendering of personalized investment, financial, legal, tax advice, or any call to action. Certain statements contained herein may constitute projections, forecasts and other forward-looking statements, which do not reflect actual results, are for illustrative purposes only, are valid as of the date of this communication, and are subject to change without notice. Actual future performance of any assets or industries mentioned are unknown. Information provided by third party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. VanEck does not guarantee the accuracy of third party data. The information herein represents the opinion of the author(s), but not necessarily those of VanEck or its other employees.

The J.P. Morgan GBI-EM Global Diversified tracks local currency bonds issued by Emerging Markets governments. The J.P. Morgan EMBI Global Diversified tracks returns for actively traded external debt instruments in emerging markets, and is also J.P. Morgan’s most liquid U.S dollar emerging markets debt benchmark.

ICE BofA G7 Government Index tracks the performance of Canada, France, Germany, Italy, Japan, UK and US sovereign debt publicly issued and denominated in the issuer's own domestic market and currency.

J.P. Morgan GBI-EM Global Diversified Index is comprised of bonds issued by emerging market governments and denominated in the local currency of the issuer.

ICE BofA China Government Index tracks the performance of CNY denominated sovereign debt publicly issued by the Chinese government.

CE BofA Developed Markets Sovereign Bonds Index tracks the performance of developed markets sovereign debt issues in developed markets.

The FTSE Chinese Government Bond Index (CNGBI) measures the performance of fixed-rate government bonds issued in mainland China.

ICE BofA Diversified High Yield US Emerging Markets Corporate Plus Index: is comprised of U.S. dollar-denominated bonds issued by non-sovereign emerging markets issuers that are rated below investment grade and that are issued in the major domestic and Eurobond markets.

Past performance is no guarantee of future results. Index performance is not illustrative of fund performance. It is not possible to invest directly in an index.

Investments in emerging markets bonds may be substantially more volatile, and substantially less liquid, than the bonds of governments, government agencies, and government-owned corporations located in more developed foreign markets. Emerging markets bonds can have greater custodial and operational risks, and less developed legal and accounting systems than developed markets.

All investing is subject to risk, including the possible loss of the money you invest. As with any investment strategy, there is no guarantee that investment objectives will be met and investors may lose money. Diversification does not ensure a profit or protect against a loss in a declining market. Past performance is no guarantee of future results.

No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of Van Eck Associates Corporation.

© 2024 Van Eck Associates Corporation.

Disclosures

Please note that VanEck may offer investments products that invest in the asset class(es) or industries included in this blog.

This is not an offer to buy or sell, or a recommendation to buy or sell any of the securities, financial instruments or digital assets mentioned herein. The information presented does not involve the rendering of personalized investment, financial, legal, tax advice, or any call to action. Certain statements contained herein may constitute projections, forecasts and other forward-looking statements, which do not reflect actual results, are for illustrative purposes only, are valid as of the date of this communication, and are subject to change without notice. Actual future performance of any assets or industries mentioned are unknown. Information provided by third party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. VanEck does not guarantee the accuracy of third party data. The information herein represents the opinion of the author(s), but not necessarily those of VanEck or its other employees.

The J.P. Morgan GBI-EM Global Diversified tracks local currency bonds issued by Emerging Markets governments. The J.P. Morgan EMBI Global Diversified tracks returns for actively traded external debt instruments in emerging markets, and is also J.P. Morgan’s most liquid U.S dollar emerging markets debt benchmark.

ICE BofA G7 Government Index tracks the performance of Canada, France, Germany, Italy, Japan, UK and US sovereign debt publicly issued and denominated in the issuer's own domestic market and currency.

J.P. Morgan GBI-EM Global Diversified Index is comprised of bonds issued by emerging market governments and denominated in the local currency of the issuer.

ICE BofA China Government Index tracks the performance of CNY denominated sovereign debt publicly issued by the Chinese government.

CE BofA Developed Markets Sovereign Bonds Index tracks the performance of developed markets sovereign debt issues in developed markets.

The FTSE Chinese Government Bond Index (CNGBI) measures the performance of fixed-rate government bonds issued in mainland China.

ICE BofA Diversified High Yield US Emerging Markets Corporate Plus Index: is comprised of U.S. dollar-denominated bonds issued by non-sovereign emerging markets issuers that are rated below investment grade and that are issued in the major domestic and Eurobond markets.

Past performance is no guarantee of future results. Index performance is not illustrative of fund performance. It is not possible to invest directly in an index.

Investments in emerging markets bonds may be substantially more volatile, and substantially less liquid, than the bonds of governments, government agencies, and government-owned corporations located in more developed foreign markets. Emerging markets bonds can have greater custodial and operational risks, and less developed legal and accounting systems than developed markets.

All investing is subject to risk, including the possible loss of the money you invest. As with any investment strategy, there is no guarantee that investment objectives will be met and investors may lose money. Diversification does not ensure a profit or protect against a loss in a declining market. Past performance is no guarantee of future results.

No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of Van Eck Associates Corporation.

© 2024 Van Eck Associates Corporation.