by Sandrine Soubeyran, Director, Global Investment Research, FTSE Russell
Major central banks have adapted their monetary policies to the changing post-Covid landscape, while most have made controlling spiralling inflation their priority, others like China, have focused on boosting growth. The question is how much can the PBoC do to avert further economic woes? The implication for markets is indeed significant, for China… and the rest of the world.
As Chart 1 shows, China’s economy had recovered well from the initial Covid crisis in 2020. However, in 2021, its growth went into reverse after the government forced the country’s large real estate industry to cut its ballooning debt, and into strict Covid lockdowns following renewed waves of Covid outbreaks, denting further the country’s economic prospects.
The gamble the PBoC (and the rest of the world) cannot afford to lose
To address falling economic growth, the People’s Bank of China, or PBoC, implemented stimulative measures and eased its key benchmark rate, cutting twice the one year loan prime rate, or LPR, reference rate in 2022 to 3.7%. It also reduced its mortgage reference rate in May to revitalise weak loan demand and stabilise the property market.
As a consequence, the PBoC’s monetary policy has moved further away from that of other major central banks, especially from early adopters of tightening stances such as the Bank of England, the Federal Reserve or the Reserve Bank of New Zealand, which started increasing interest rates in late 2021 (Chart 2). Elsewhere in Asia Pacific, South Korea has been steadily increasing rates, while India, Malaysia and Philippines are just at the start.
As a result, Chinese assets have been losing some yield advantage. As Chart 3a highlights, foreign holdings of Chinese government bonds have decreased for three consecutive months since February in favour of US Treasuries, as investors capitalised on the extra yield pick-up. Differences in rates have also affected currency markets, with the disappearance of any yield advantage over US Treasuries affecting the Chinese currency negatively leading to its weakening vs the US dollar (Chart 3b).
Chinese conventional bonds fell from their perch in May
The more dovish stance adopted by the PBoC has also impacted the performance of Chinese sovereign bonds. As Chart 4 demonstrates, Chinese government bonds (down 0.5% in US dollar terms) lost some of their resilience in May and their top place in the performance table. However, returns for Chinese sovereigns have been less negative than peers since January 2022 and shown to be a place of relative safety for investors.
Can Chinese government bonds maintain their performance advantage going forward? Deciphering how much tightening is already priced in other markets should provide the clue.
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