Improved market conditions for RMB bonds support recovery in recent performance
RMB bond market performance lagged behind earlier this year due to tightness in money market liquidity. Money market and swap rates had been elevated since late last year, which is normal during certain short periods of the year. However, the effect was exacerbated this time due to sharp depreciation of many currencies other than the USD. This had spurred demand for currency hedging, pushing the cross currency swap (CCS) rates sharply higher to uncommon levels. Tight liquidity and high CCS rates raises the cost of holding RMB bonds and had consequently created some selling pressure.
Fortunately, these conditions had led yields to attractive levels, giving rise to good investment opportunities for investors. With a stabilisation in the RMB currency and increased expectations for loose monetary policy, we have now seen a marked improvement in liquidity conditions since mid-March, supporting a recovery in RMB bond performance, which we believe has just begun. RMB bonds are offering attractive yields of close to 5%, while duration of the market is low. In our view, this is one of the best value credit markets globally.
Offshore RMB bonds recover from earlier weakness
Source: HSBC, data as of 12 May 2015, performance is calculated according to the HSBC Offshore RMB Bond Index. Investment involves risks. Past performance is not indicative of future performance.
Reduced speculation on the renminbi supports a moderate appreciation of the currency going forward
Since mid-March, the currency has strengthened and remains relatively robust, on reduced speculation of further RMB depreciation, supporting overall bond market sentiment. As Premier Li Keqiang puts aptly, China does not want to see further devaluation of the RMB as they cannot rely on devaluing their currency to boost exports. A weak RMB is not a policy objective in China. This point, along with China’s strong macro fundamentals, such as an interest rate differential with the rest of the world, supports our medium term outlook for a moderate appreciation of the currency.
Continued loose monetary policy conditions will benefit RMB fixed income
People’s Bank of China (PBoC) has cut interest rates three times since November 2014, while cutting reserve requirement ratio (RRR) in February and April. It is entirely expected that the Chinese authorities would continue to loosen monetary policy to cushion the economic slowdown. Generically, looser policy and especially cuts in policy rates are good for fixed income as sovereign yields are a function of future interest rate expectations, while corporate bonds should prosper with lower borrowing costs for companies. The loosening monetary policy measures have pushed onshore bond yields sharply lower since 2014. These factors are definitely positive for RMB fixed income markets, including the offshore RMB bond market.
China is in a rather unique position. At this time, the US appears to be closer to hiking interest rates. Over in Europe and Japan, though they are also on a clear loosening path, rates have already reached near zero or even negative levels, with limited room for further moves. The difference with China is that real interest rates and RRR are still relatively high; hence PBoC does have room to cut rates further. This will be supportive of bond market performance going forward.
Making the case for RMB fixed income
The relative value of the offshore RMB market is highly compelling and, we believe, set to attract more investors who are grappling with a world of thin returns in developed markets. To put this in perspective, US corporate bonds (according to the BoA US Corporate Index as of 30 March 2015) come at a yield of 3% and a duration of 7 years while Euro corporates (equivalent index as of 30 March 2015) come at less than 1% with 5 years of interest rate risk. Closer to home, yields in Hong Kong are low (as of 30 April, 10-year Hong Kong government bonds yielded 1.483%), but still yield more than those in Austria, Belgium, Denmark, Finland, France, Germany, Ireland, Spain, Sweden, and Switzerland. Offshore renminbi bonds, which have a higher average quality than either of US and Euro corporates, now yield over 5% for a duration of just 2.5 years.
The high starting yields and low duration of the bond market also give it very resilient and uncorrelated qualities. A sharp rise in US yields is unlikely to seriously damage returns from this market. Equally, a turnaround in Euro yields should not have a deleterious effect. In a low yielding, dangerous fixed income world, the offshore RMB market could be part of the solution for investors struggling to generate returns.
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Investment involves risk and past performance is not indicative of future performance.
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