SSGA: Why Chinese government bonds warrant attention… and caution
The Chinese Government Bond (CGB) yield's decline since the turn of current decade has come to be viewed in some quarters as symptomatic of China’s losing battle against the Japanification of its economy and bond market.
'The worry is that China’s deflationary cycle will persist, with the drop in interest rates mirroring falling wages and investment – something that has been compounded by stalling consumption – in the absence of strong and decisive fiscal stimulus measures,' Masahiko Loo, Senior Fixed Income Strategist at State Street Global Advisors, explains. 'But it should be noted that large fiscal stimulus did not save Japan from the period known as its 'lost decades'. In the case of China, we doubt whether supply-centric stimulus spending would be effective enough when the underlying issue is a deficit in demand.'
Why investors shouldn't ignore CGBs
When we plot the returns of USD-hedged CGBs and Japanese Government Bonds (JGB) over the last 20 years, we see the divergence of performance in the latest five-year period as CGBs outperform. Therefore CGBs should not be ignored by investors, particularly as their low volatility is virtually unrivalled in today’s highly uncertain environment for fixed income. China bonds also add an element of diversification to investment portfolios, presenting a stark contrast to volatile and higher-for-longer rates expectations in developed markets.
'We think it is unlikely that China will pivot to stimulate growth on a massive scale, and that the most likely mid-term path forward is more rate cuts. High household savings and lower loan demands would leave banks flush with cash — that is generally a favorable environment for bond markets. Furthermore, the China bond market is arguably too big for investors to ignore at this point, as it accounted for more than 10% of the Bloomberg Global Aggregate Index at the end of December 2024,' Loo outlines, adding that a key factor keeping investors away from investing in China is geopolitical risk around Taiwan.
