Are Chinese Bonds A Safe Haven?
It is well documented that in times of geopolitical crisis and economic upheaval, investors flee to safe havens such as gold, Switzerland and U.S. treasuries (U.S. Government Bonds). However, during the recent United States/Iran/Israel conflict, Chinese Government Bonds (CGBs) have emerged as a surprising safe haven where global asset managers have been adding these bonds to their portfolios.
Interestingly, investors have not been attracted by yields but by their virtual non-correlation with markets in the west. Indeed, since March, analysts advise that in Japan, Europe, the US, yields have soared between circa 35 – 60 BPS (Basis Points) as investors sold government bonds, whereas yields on CGBs have declined by 8bps.
Real money investors* have been attracted by the price stability of CBGs where there are being offered a preservation mandate as a counter balance to high-yielding riskier assets on portfolios. Indeed, during the current conflict, many asset managers reviewed their portfolios and bought into CGBs despite Chinese yields being pushed to the lowest in the market except for Japan and Switzerland.
*Real money investors — These are institutional investors such as asset managers, sovereign wealth funds, pension funds, insurance companies and traditional mutual funds who invest on an unleveraged basis. This is in direct contrast to what is generally referred to as ‘fast money investors’, such as hedge funds who are highly leveraged and trade heavily on debt, and further rely on short-term trading strategies and derivatives to amplify returns.
The world has seen energy prices go through the roof since the start of the Middle East conflict on the 28th February this year resulting in inflation problems for many major economies. This has had a negative effect on government bonds, especially those bonds from Europe and the United States being held by investors, whilst bonds issued by the government of China have remained relatively inflation free.
Unlike many other countries, China holds significant reserves of energy, and as a result did not suffer an immediate supply shock, which resulted in domestic inflation remaining subdued. Further positive effects on inflation have been helped by a dovish monetary policy stance by China’s central bank, the People’s Bank of China (PBOC), which has resulted in a calm, low volatility, government bond market.
Experts have said that key drivers driving renewed foreign investment interest are the near zero-correlation to western markets and low volatility. In contrast, U.S. treasuries have been caught between competing forces where inflation expectations have seen treasuries go up, and safe haven demand has seen them go down — resulting in unpredictability for portfolio managers.
However, contrary to western financial markets, analysts advise that there are certain risks involved when investing in the Chinese bond markets, or China as a whole, as they operate under rules that differ from those found in Europe or the United States. For example, the dovish monetary stance by the PBOC may not last forever, resulting in a differing dynamic for government bonds. China’s capital controls could result in getting investments out of China, a difficult proposition, and geopolitical tensions between the west and China could possibly lead to sanctions making investments difficult to repatriate.
On the currency front, experts in this arena advise that increasing foreign capital inflows into China might place the Chinese Yuan under upward pressure and reduce the foreign currency values of inward investments in China. However, there appears to be a large shift in trust towards the Chinese bond market, as some experts and analysts advise that China is no longer seen as uninvestable, and no doubt all potential risks have been scrutinised by all the relative institutions risk management and compliance teams.
