360 views on China fixed income outlook

Onshore, offshore opportunities, and currency prospects

China 25 Jun 2019 5 min read

Hayden Briscoe

Head of Fixed Income, Asia-Pacific

Slowing growth, narrowing yields

Clouds are on the global growth horizon. Trade tensions bring uncertainty to the global outlook and the IMF has cut its growth forecast for 2019 to 3.3% from 3.5%¹.

That means fixed income investors have a problem: in a world where real yields are negative in Germany and Japan and narrowing in the US, where do you hide out?

Hayden Briscoe, Head of Fixed Income APAC, thinks now is the time for China fixed income and here are his 360 views on China fixed income: onshore and offshore opportunities, and the outlook for the RMB.

China's L-shaped recovery

China is in the midst of what we believe is a L-shaped recovery. Policy support has put a base under the economy, and we are expecting growth to stabilize in H2 2019.

Demand for real estate is outstripping supply in China too, and that means we expect a flurry of construction activity soon that will ripple through the economy and support the outlook.

Going further, we're expecting additional monetary stimulus from a combination of rate cuts, RRR cuts, and open market operations.

Bringing onshore opportunities into focus

And as we put these pieces together, it adds up to a strong case for Chinese government bonds because:

China government bonds offer positive nominal and real yields and that's rare in yield-starved global markets;
Low correlation to risk assets – historically, government bond yields have had low correlation to risk assets and are increasingly seen as a safe-haven asset;
Capital appreciation prospects if, as we expect, the Chinese government eases policy further and yields compress onshore in the coming months.

China High Yield - vibrant offshore opportunities

Looking outside of China government bonds, we also see value in the China high-yield (HY) market because:

Credit conditions within China's real estate sector – the largest sector in the onshore market for high yield credit – are improving amid strong sales and ongoing deleveraging
The tilt towards more dovish policy by global central banks provides a favorable backdrop for China high-yield bonds.

In addition, we also see value in the China high-yield (HY) market because it offers more attractive yield pickup opportunities compared to US HY and Euro HY while the duration is also shorter².

Attractive yield pickup in China high-yield bonds

RMB to weaken – but not to worry

We do expect the RMB to depreciate in the coming months, but that shouldn't worry investors unduly. Costs for RMB hedging have been at close to zero for the past 12 months, so investors can hedge their currency risk with very little cost.

In closing, we feel that as investors increasingly recognize the underlying dynamics of China's bond markets, plus the attractive opportunities on offer, it amounts to a compelling case for why now is the time for China fixed income.

In China's property sector, demand is outstripping supply, large developers look fundamentally stronger than smaller developers in the current environment. Relative to other markets, China high-yield real estate fixed income looks good value.

Hayden Briscoe, Head of Fixed Income, Asia Pacific

¹ IMF, World Economic Outlook, July 2019

²Source: Bloomberg, J.P. Morgan. As represented by Bloomberg Barclays indices and J.P. Morgan Asia Credit Index China Non Investment Grade (China High Yield). As at 19 June 2019, *5yr generic bond spread between US and China government bonds Bloomberg 20th June 2019. China HY duration: 2.4 years; US HY duration: 3.3years; Euro HY duration: 4.2years.