Foreign holdings of Chinese debt grew at the fastest rate on record during July and August as the yuan rose against the dollar and the Chinese economy evinced clear signs of economic recovery.
Foreign holdings of onshore bonds rose to 2.86% of the total market in August 2020 from 2.52% at the end of 2019. Foreign purchases were concentrated in government and quasi-governmental policy bank bonds. Foreign ownership of Chinese corporate bonds comprises a minuscule portion of the total.
China’s 5-year Treasury note yields almost three percentage points more than the US Treasury 5-year note. That’s the widest gap since the middle of 2013, when the Chinese currency traded at 6 to the US dollar.
We think the RMB exchange rate is headed back to its 2013 high, with a short-term technical target of CNH 6.67 to the dollar and a medium-term fundamental target of 6 to the dollar.
The inclusion of Chinese government and policy bank bonds in major bond aggregate indices will attract increasing capital flows into China and put upward pressure on the currency.
With the RMB rising and foreign portfolio investment increasing, the People’s Bank of China will face no pressure to ease monetary policy, as viable borrowers will fill an increasing proportion of their credit needs on capital markets.
Chinese bond yields made a V-shaped recovery during 2020, regaining their early-2020 levels as China’s economy snapped back to previous growth levels.
US bond yields, by contrast, remain at record lows as the Federal Reserve leans against stubbornly high unemployment, continued distress in the real state sector and record peacetime US budget deficits.
When the RMB briefly touched 6 to the dollar in early 2014, China was in full-fledged deflation, with factory prices and profits depressed by excessively tight monetary policy.
China had no choice but to ease monetary policy and allow the RMB to depreciate, which it did rather chaotically starting in August 2015.
Chinese requirements today are quite different. The economy is growing without excess monetary stimulus. China’s government is emphasizing domestic demand rather than export growth under the new “dual circulation” rubric.
The uncertain and halting recovery of China’s major markets overseas as well as the threat of additional trade restrictions from the US has motivated a shift in Chinese emphasis towards domestic consumption. That implies less export and more import of capital through a lower trade deficit and higher portfolio investment within China.
A strengthening currency helps. China’s gross national savings reached 50% of gross domestic product (GDP) in 2008 at the peak of the country’s export drive, and fell to 44% of GDP in 2019. We expect China’s savings rate to fall further as the country increases domestic consumption in part through higher imports.
The strong inflows into onshore debt were accompanied by comparable purchases of dollar bonds issued offshore by Chinese entities. Sales of dollar-denominated bonds from Chinese issuers reached an all-time high of $23 billion in August and underwriters received $7.60 in orders for every dollar of available paper, according to Bloomberg data.
Foreign ownership of Chinese equities, meanwhile, rose to 3.79% of the total market in August 2020 from 3.54% at the end of 2019. Chinese government data showed net portfolio inflows into China were at a near-record during the second quarter of 2020.
Exante Data reports that portfolio inflows into China reached $20 billion – an annual rate of $240 billion – during July, the highest month on record.
Equity markets drew in slightly more foreign cash than fixed income as of June, Chinese government data indicate. It appears that the big surge in foreign bond investment took off in July and August.
Foreign capital inflows driven by a rising RMB will support increased spending to promote consumption. China’s local government bond issuance rose 110% year-on-year to 1.2 trillion yuan ($175.4 billion) in August, according to the Ministry of Finance.
In that direction, Asia Times reported on September 10, “Infrastructure supporting new consumption types needed to be built at a faster pace. Central business districts, industrial parks and transportation hubs would be prioritized in planning 5G and internet of things networks.”