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China Bond Bulls Unfazed as Growing Crackdowns Spook Markets

(Bloomberg) — While Chinese markets might look bleak at the moment, the biggest government bond selloff of 2021 has some investors salivating at a buying opportunity.

Risk aversion swept the country and spread globally this week after China cracked down on private-education firms. Although reassurance from state media on Wednesday helped stem a selloff in stocks, sentiment remains fragile. The same goes for bonds.

And, yet, bulls including Ashmore Group, Alpine Macro and VP Bank AG are undeterred. The drivers that have made Chinese bonds the best performers in the world this year are still in place. Their higher yields, lack of correlation with other markets and China’s conservative deployment of stimulus should keep investors interested, especially since near-zero interest rates remain the norm around the world.

“The Chinese bond market is very resilient,” said Gustavo Medeiros, London-based deputy head of research at Ashmore, which oversees about $94 billion in assets. “Chinese bonds are the only major bonds in the world that will actually provide a proper protection in a global systemic event because it’s the only central bank in the world that still has a big bazooka. And Chinese bond yields are trading at a higher level than the European or U.S. bonds.”

China’s stock market has been hammered this week after President Xi Jinping’s sudden policy change on education companies — which built on crackdowns on technology firms — raised concerns that a swathe of industries may come into the crosshairs of regulators. The contagion spread to other assets Tuesday, sending the yield on benchmark 10-year government bonds up four basis points to 2.92% in the biggest selloff since November.

The offshore yuan fell about 0.7% to the weakest level since April. It rebounded 0.2% on Wednesday in Asia while bond yields inched higher. State media moved to talk up the market Wednesday, asserting that declines were unsustainable and equities should stabilize quickly. The CSI 300 Index closed 0.2% higher after falling as much as 1.8% in early trading.

China Stocks Swing From Gains to Losses as Media Calls For Calm

VP Bank AG, which made its first-ever allocation into Chinese bonds within its discretionary portfolio last month, is staying bullish on the market.

“We like Chinese bonds because they add additional diversification benefits to the portfolio. They’re not highly correlated to other asset classes, not even other sovereign bonds,” said Chief Investment Officer Felix Brill, which oversees about 50 billion Swiss francs ($54.6 billion) in assets under management. “There have been strong inflows from foreign investors since the opening of the bond market, but this has just started and it’s going to continue.”

Tuesday’s selloff has been rare for a market that was seen as a magnet for foreign capital. Overseas funds net bought China’s government bonds in all but one month since the start of 2020, pushing holdings to an unprecedented level in June.

Those flows helped drive 10-year yields down 22 basis points this year, the most among major markets. The rally accelerated this month as policy makers reduced the reserve requirement ratio for the first time in more than a year to support economic growth.

Long-Term Impact

“The recent events shouldn’t have any long-term impact on the yuan or bonds,” said Yan Wang, chief emerging-market and China strategist at Alpine Macro. “China hasn’t done large-scale fiscal and monetary stimulus. Compared with the massive fiscal deficit and massive current-account deficits in the U.S., the yuan is fundamentally sound.”

And even if the stock-market rout starts to tighten financial conditions and leads to an economic slowdown, the central bank may ease policies, Medeiros said. This would benefit bonds.

Strategists at DBS Group Holdings Ltd. concur. They argue that the selloff in equities is unlikely to materially alter the medium-term outlook for government debt and markets will probably continue to price in expectations for an easing in the near term.

China Bond Rally Gains Momentum as Risks Show Up Everywhere

Chinese debt may also see some support as some of their biggest investors include central banks with longer horizons. According to estimates from the Institute of International Finance, central banks’ reserve accumulation in yuan accounted for 60% of inflows into China government bonds in the first quarter and a third of flows last year.

“Half of foreign ownership of Chinese government bonds are foreign sovereign institutions, who are real money and long-term investors,” said Xing Zhaopeng, senior China strategist at Australia & New Zealand Banking Group Ltd. in Shanghai. “Despite the recent rout, the long-term outlook for China bonds remains the same as there won’t be any changes to index inclusion even with rising tensions with the U.S.”

(Updates with views from VP Bank in 7th and 8th paragraphs)

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