According to the relevant statistics of bondcom, at the end of January 2022, overseas institutions net increased their holdings of domestic RMB bonds by 66.3 billion yuan to 4.07 trillion yuan, rising for 10 consecutive months. Among them, the amount of Bond Custody of overseas institutions in the Central Clearing Company increased by 50.1 billion yuan to 3.73 trillion yuan, rising for 38 consecutive months. Although the current economic situation is becoming more complex and changeable, China is facing “triple pressure”, high foreign inflation and strong expectations of monetary policy tightening, international investors are still full of confidence in the long-term prospects of China’s economic growth and choose to continue to increase their holdings of RMB assets. What are the reasons behind this and how to treat this phenomenon?
the convergence of China US interest rate spread is expected
From the perspective of the whole year, the GDP growth difference between China and the United States in 2022 may hit a new low since the 1990s. However, from the perspective of trend, China’s economic growth is high before and low after, while the US economy may slow down quarter by quarter. Compared with the gradual weakening of the effect of the US stimulus policy, there are many positive factors for China’s economic growth this year. With regard to the factors that exacerbated the downward pressure on economic growth in the second half of last year, the five “correct understandings” and “standing first and then breaking, steady and steady” of the central economic work conference held at the end of last year will be corrected in time, and some structural blockages will be alleviated to further release economic vitality.
The convergence of interest rate spread between China and the United States will affect the inflow of foreign capital to a certain extent. High inflation and tight monetary policy in Europe and the United States will gradually push up the Treasury bond yield, while the market is generally expected that China will still maintain a slightly loose monetary policy, and China’s treasury bond yield may be easy to fall but difficult to rise. As of February 15, the yield difference between China and the United States 10-year Treasury bonds had decreased by 51 basis points to 74.5bp compared with the end of last year, which was lower than the “comfort range” of 80bp-100bp.
However, the convergence of interest rate spread between China and the United States has been expected. Affected by this, in January, the net increase in overseas holdings of domestic RMB bonds decreased by 5% month on month and 70% year-on-year. Even so, foreign investors still rarely reduce their net holdings of RMB bonds. Because for the world’s second-largest economy, RMB bonds may still be in an “under allocation” state in the allocation of foreign investors.
According to the data of the Central Clearing Company, the custody of bonds of overseas institutions accounts for only 4.24%, which is far lower than about 30% in the United States. In addition, the structure of RMB bonds held by foreign investors is relatively single, of which national debt and policy financial bonds account for 68% and 29% respectively. There is still much room for the development of enterprise and corporate credit bonds in the future.
security liquidity promotes foreign capital to increase positions
The “great changes not seen in a century” and the century epidemic continue to affect the global economy. There are not many foreseeable overseas risks this year, such as the tail of the epidemic, the US mid-term elections, inflation risks (energy crisis, food crisis and supply chain rupture) and the tightening of the Federal Reserve. On the contrary, many policies and economic situations in China point to stability. This is attractive to foreign investors who want to reduce the volatility of asset allocation.
First look at security. During the epidemic period, there were many combinations of repeated overseas epidemics, convergence of interest rate differentials between China and the United States and substantial increase of foreign holdings of Chinese bonds. Chinese and foreign investors have said that RMB assets have the property of hedging. At present, the dislocation of economic and policy cycles between China and the United States may “naturally” form a weak or even negative correlation of assets.
Overseas, high inflation and the tightening of the Federal Reserve may trigger the market to further sell off US bonds, and the upward yield will undoubtedly put pressure on the valuation of the equity market. On the Chinese side, the people’s Bank of China has reached a consensus on “focusing on the inside”. Practical actions such as reducing the reserve requirement at the end of last year and the beginning of this year show that steady growth is inevitable.
In terms of exchange rate, the International Monetary Fund (IMF) has warned many times that emerging markets should be vigilant against the flight of foreign capital caused by the tightening of the Federal Reserve, which will also affect China, but also praised China as the “ballast” of emerging markets. The strong trend of RMB exchange rate has also further improved the motivation of foreign capital to stay in China. However, this will also aggravate the monitoring pressure of the regulatory authorities on the foreign exchange market and cross-border capital flows to a certain extent, which can be described as “sweet trouble”.
Look at liquidity. As early as 2019, China’s bond market has jumped to the second place in the world, second only to the United States. In January this year, the average daily trading volume of the inter-bank market reached 5.3 trillion yuan, far exceeding the foreign capital holdings. Coupled with the increasingly perfect bond derivatives market, foreign investors do not worry about the liquidity of RMB assets. In addition, China’s two-way financial opening-up has been expanding in recent years. The 14th five year plan proposes to comprehensively improve the level of opening-up, promote trade and investment liberalization and facilitation, and the level of two-way connectivity has increased significantly.
In February 2020, Chinese government bonds were included in JPMorgan’s emerging market government bond index; In November 2020, China’s treasury bonds and policy financial bonds were fully included in the Bloomberg Barclays global composite index; In October 2021, China’s treasury bonds were included in the FTSE world treasury bond index. In just two years, treasury bonds have been included in the three major global bond indexes, which has further enhanced the attractiveness of RMB bond assets.
At present, except Japan, monetary policies in developed countries are almost one-way tightening. Even recently, the European Central Bank has changed its mouth to say that it needs to be vigilant against high inflation. This will have a certain adverse impact on the exchange rate of the currencies of emerging economies. IMF research found that the broad dollar index compiled by the Federal Reserve has a strong negative correlation with capital flows in emerging economies. The strength of the dollar in 2021 has begun to curb capital inflows into emerging economies. In addition, there is still room for the US 10-year Treasury bond yield to rise. Coupled with the potential international financial turmoil caused by the tightening of monetary policy, life in most emerging economies is not easy.
rational view of the relationship between exchange rate and foreign capital position increase
Although the factors affecting the RMB exchange rate and foreign investment in RMB assets overlap, the mechanism and influence are different.
Taking the interest rate difference between China and the United States as an example, domestic investors are still the main force determining the yield of treasury bonds, and pay more attention to the decision-making of the people’s Bank of China. Foreign investors pay more attention to global asset allocation, focusing on the Fed’s decision-making and the potential trend of US bond yield, which has a relatively limited impact on RMB bond yield, and need to take into account the change of exchange rate.
At the same time, in different stages, the above logic will also change with the consensus of investors. Taking 2018 as an example, the deviation of China US monetary policy and trade disputes led to the continuous depreciation of RMB and the narrowing of China US interest rate gap, but the net inflow of foreign capital still bucked the trend. This is because although the depreciation of RMB will reduce the profit of stock foreign capital, it will reduce the cost of incremental foreign capital.
In addition, the RMB exchange rate has a stable foundation. China’s higher current account surplus and less external liabilities, especially foreign currency liabilities, are able to cope with the exchange rate fluctuations caused by the tightening of global US dollar financing. A stable exchange rate environment will help reduce the exchange rate risk cost of foreign capital allocating RMB bonds. It is undeniable that the foreign exchange demand for foreign capital to purchase RMB assets is a part of the total foreign exchange demand. If foreign capital makes up the US dollar market, it still has the ability of marginal disturbance to the RMB exchange rate.
(author: Boc International (China) Co.Ltd(601696) global chief economist Guan Tao)
