Noble Apex eNewsletter Issue 806- China onshore bond market: An asset class not to be missed

2019-04-29 07:26
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29 April 2019 Issue 806

Global Market Commentary

Equity

  • US: The United States’ annual GDP grew by 3.2% in the first quarter of 2019, far exceeding market expectations, making the market holds an optimistic view towards the US economic prospect. For the entire week, the Dow fell by 0.06% to 26,543.33. The S&P 500 index rose by 1.20% to 2,939.88. The Nasdaq rose by 1.85% to 8,146.40.
  • Europe: European stock markets have developed individually. Driven by technology stocks, the German stock market performed well in last week. However, both the UK and France stock markets have fallen. For the whole week, the UK’s FTSE 100 index fell by 0.42%, the German DAX index rose by 0.76%, and the French CAC40 index fell by 0.20%. The STOXX 600 index rose by 0.14% for the week to 391.01 points.
  • Asia: South Korea’s real GDP in the first quarter of 2019 unexpectedly decreased by 0.3% from the previous quarter, which is the biggest decrease since the end of 2008, dragging down Asian stock markets. Over the week, the Nikkei 225 index rose by 0.26% to 22,258.73 points. The MSCI Asia Pacific Index fell by 0.57% to 162.14 points.

Bonds

  • US: The US GDP growth in the first quarter of 2019 was 3.2%, which was much higher than market expectations. However, the sub-indices showed that the demand growth was weaker than the overall growth, causing the US 10-year bond yield fell. For the whole week, the US 10-year bond yield fell by 6 basis points to 2.498%.
  • Europe: The results of the German Ifo Business Climate Index were disappointing, causing the market to switch their investments to the risk-averse market. For the whole week, the German 10-year bond yield fell by 5 basis points to 0.023%.

Commodity

  • Oil: It is reported that Germany and Poland worried that Russian oil is being polluted and will stop importing Russian oil from the Druzhba pipeline. Over the week, New York oil futures fell by 1.20% to close at $63.30 a barrel.

Currency

  • US dollar: The US annual GDP grew by 3.2% in the first quarter of 2019, far exceeding the market expectation of 2.3%. For the whole week, the Dollar Index rose by 0.645% to 98.006.
  • China: US GDP data is better than expected, making the dollar strong. For the whole week, the yuan fell by 0.468% against the US dollar at 6.736.

 

Economic-related News

  • US: Chinese and US officials will continue economic and trade consultations in Beijing on April 30. The White House said the negotiations will involve trade issues such as intellectual property rights, compulsory technology transfer, non-tariff barriers, agriculture sector issues, services sector issues, procurement and enforcement issues.
  • U.S: The US annual GDP growth was 3.2% in the first quarter, far higher than the market expectation. The inventories and trade sectors gave the economy a strong boost, offsetting the slowdown in consumer spending. Trump said that if there is no interest rate hike, GDP growth will be higher.
  • U.S: Trump said that he has discussed with countries such as Saudi Arabia, to increase oil supply and claimed that everyone agreed on it. The oil price hit the biggest drop within these two months.
  • Euro-zone: The spokesperson for British Prime Minister Theresa May said that the British government and the opposition party, Labor Party, will continue to discuss on the Berxit issue this week to seek to break the deadlock.
  • Euro-zone: The French Statistical Office (INSEE) announced that the French consumer confidence index unexpectedly ended the upward trend, only stabilizing at 96, lower than the market expectation of 97.
  • Euro-zone: The German Institute for Economic Research announced that after the seasonal adjustment, the German Ifo Business Climate Index unexpectedly fell back to 99.2 in April, the market originally expected to be 99.9.
  • Japan: The Bank of Japan adjusted its monthly bond purchase plan for the second time this year, paving the way for a reduction in bond purchases in May as Japan’s benchmark yield remains below zero.
  • Japan: The Ministry of Internal Affairs and Communications announced that Tokyo’s Consumer Price Index (CPI) rose from a 0.9% increase to a 1.4% increase in April, far higher than the market expectation of a 1.1% increase.
  • Australia: The Australian Bureau of Statistics announced that the growth rate of the Australia’s Producer Price Index (PPI) in the first quarter of this year slowed down slightly to 1.9%, and the quarterly increase also slowed down slightly to 0.4%.

 

China Market Commentary
Economic-related news
• Xi Jinping, Chinese President, said at the One Belt, One Road Roundtable Summit on Saturday that the global economy is lacking of momentum and is facing downward pressure. Xi Jinping also said that during the “Belt and Road” forum, the project cooperation agreements that signed by parties were worth more than 64 billion USD.
• China’s total profit of industrial enterprises above designated size grew by 13.9% year-on-year in March, reversing the decline trend in January and February.

China onshore bond market: An asset class not to be missed

Following the introduction of China – Hong Kong Bond Connect in July 2017, we have recently witnessed another important milestone in the long-term liberalization of China onshore bond market, i.e., the inclusion of China’s sovereign and policy bank bonds into the widely tracked Bloomberg Barclays Global Aggregate Index. The inclusion will be implemented over a 20-month period starting April 2019, and the process is expected to be slow and gradual. Upon completion, 364 Chinese securities will account for 6.1% of the $54.9 trillion index and the yuen-denominated debts will then form the fourth-largest currency component behind the dollar, euro and yen in the index. Among the 364 bonds that will be included in the index, the mix will be as follows:

– Chinese government: 159

– China Development Bank: 102

– Agricultural Development Bank of China: 58

– Export-Import Bank of China: 45

 

The move is critical and meaningful to both China government and global investors as it would be an important step to integrate Chinese markets in the global financial system and help advancing RMB internationalization. Besides, it helps to diversify China’s sources of funding, and China needs foreign capital to finance its slowing economy in particular as the country’s current account is expected to swing into a deficit in the coming years. China is now gradually transforming into a more service-oriented economy, and would have a high tenancy for imports, putting additional pressure to its trade deficit onwards.

 

On the other hand, China onshore bonds market is a massive $13 trillion debt market, the world’s third-largest after the U.S. and Japan, and this’s a market that foreign investors should not be missed. In fact, China onshore bonds offer global investors a meaningfully higher yield than other major markets. For example, China’s 10-year government bond yielded at about 3.1%, compared with 2.4% on equivalent US, 1% on UK and 0.4% on France sovereign notes respectively. In addition, China onshore bonds, which has been dominated by domestic investors, could offer considerable diversification benefit to foreign investors and help them to reduce their portfolio volatility as the correlation between Chinese bond and US Treasury prices has been almost zero over the past few years. However, this benefit may gradually diminish as foreign investors participation in China’s bond market rises over time.

 

Meanwhile, foreigners’ share of China bond market is about 3.4% only, but it is growing exponentially from less than 2% last year ($248bn in 2018 and $183bn in 2017). In fact, the average daily trading volume on the China-HK Bond Connect increased to RMB5.9bn during 1Q19 compared to RMB3-4bn in 2017 and 2018, and is likely to exceed RMB7.5bn on April per our estimate. Another measure of foreign participation, i.e., the number of registered international institutional investors in Bond Connect Scheme, have increased to 711 at the end of March 2019 (vs. 500 at the end of December 2018), reflecting foreign interests in China bonds is rising drastically. With index inclusion starting April 2019, it could provide another boost to the transaction volume on Bond connect and may bring passive inflows of $120-$135bn to the China onshore bond market, according to Citi and Goldman Sachs forecast.

 

Figure 1.

Source: Bond Connect Company Limited, Noble Apex/iFund

 

In overall, we see China’s inclusion in global bond benchmarks is a key event to global investors, which is equally as important as the increase of inclusion factor of China A shares in the MSCI index. Looking forward, China still have to put much more efforts to further open up its debt market, such as the needs of developing more interest-rate derivatives that meet the hedging needs of foreign investors as well as the importance of having a more recognized and reliable credit ratings system as comparable to international standards. We believe China bonds would become a very important asset class for global investors in future, especially corporate bonds remains heavily under-penetrated, with international investors accounts for less than 1% of the total corporate bond at present.

 

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