The smart money is moving into China fixed income: overseas investors were the top buyers onshore in May and boosted their holdings 94.9% y-o-y. Looking at our flows, EU and Japanese clients are dominant; that's hardly surprising considering the low-to-zero yields in their domestic markets.
It's also because China fixed income has been a top performer this year, rewarding investors with diversification and strong performance vs. global markets. Looking ahead, we continue to see it as a space to invest tactically and strategically, particularly because the outlook for the global economy is going to change, and that's because of China.
Firstly, a word on trade
Thinking about global strategy, we're prepared for a lot of noise on the China-US trade relationship past the first round in July all the way into the US midterm November elections.
For starters, Trump's focus on the US-China merchandise trade deficit misses the sizeable surplus in services, notably Chinese tourism.
Secondly, there's the issue of what impact US-China trade tensions will have on the global economy. This isn't a hard, Brexit-style structural change in the trading relationship, we think about it as a dust up between two countries who ultimately can't survive without each other.
Finally, focusing on trade issues misses out what's really impacting the global economy, and for that you have to look at how China is conducting monetary policy.
China has been tightening monetary policy during the past 18 months, and that's meant clampdowns on shadow banking, controls on wealth management products, curbs on local government debt, and limits on real estate lending.
Domestic trends matter
How this policy impacts the domestic economy directly translates into global growth, and signs of a domestic slowdown are becoming obvious.
We're seeing a growing number of defaults onshore in China because new regulations don’t allow certain borrowers to fund in loan or bond markets and are putting smaller joint stock, city commercial and rural banks under pressure in the wholesale funding markets we invest in.
As credit policy has tightened, so money supply growth has slowed noticeably, feeding into much weaker growth in fixed asset investment (FAI) (see Exhibit 1).
Importantly, FAI is the bedrock of China's economy, accounting for 50.6% of total GDP in Q1 2018, and when growth slows in this segment, so the outlook deteriorates for China.
Exhibit 1: FAI and M2 Growth (% - YoY 3M MA), July 2008-May 2018