Bond market to attract more overseas capital

China's nearly $14 trillion bond market is likely to see a substantial increase of foreign capital inflows this year as higher yields, a relatively stable yuan and further opening of the onshore market have made Chinese bonds an increasingly attractive asset for global investors.

Foreign investors made a net purchase of Chinese bonds worth 1.1 trillion yuan ($160 billion) in the interbank bond market last year, according to the latest figures from the China Foreign Exchange Trade System. As of December, the total value of yuan-denominated bonds held by overseas investors reached 2.19 trillion yuan, up by about 26 percent from the level of 2018, according to financial data provider Wind Info.

Foreign purchases of Chinese bonds will likely rise further as the low-yield environment in global bond markets and the meager expected returns from core government bonds have prompted yield-chasing investors to look at other options. Many of them believe that the Chinese bond market will stand out to be the one that could offer one of the best opportunities this year.

"We are living in a world today where more and more debts have become negative yielding. And this is forcing global investors to look further away ... and explore new markets that are opening up — in particular, the Chinese market," said Hayden Briscoe, head of fixed income for Asia-Pacific at UBS Asset Management.

Governments in major economies have adopted accommodative monetary policies to stimulate growth, which has caused a dramatic fall in government bond yields and took nearly a third of global bonds into negative-yielding territory at one point last year. Investors started to be concerned that the monetary easing could be exhausted and any policy normalization could send interest rates and bond yields higher, which would depress bond prices.

In the case of China, foreign investors' consensus is that the Chinese policymakers will continue with a relatively easing policy stance to shore up growth, and further interest rate cuts by the Chinese monetary authority in the first half of this year are possible. That's a positive signal for the Chinese bond market.

Alvin Cheng, a fixed-income portfolio manager at international asset manager Fidelity International, said in a research note that China's bond yields will remain relatively attractive this year, which should continue to draw more foreign participation. Cheng added that China's growth is still under pressure with structural adjustment and declining interest rates have been the market consensus.

The bullish sentiment toward Chinese bonds was also supported by the expectation that Chinese regulators will further liberalize the onshore financial markets and remove investment barriers for foreign investors. Meanwhile, the growing inclusion of Chinese bonds in major global indexes will also draw more foreign capital inflows.

China has the world's second-largest bond market and yet foreign investors have a very small exposure as their holdings only account for about 2 percent of the total value of the Chinese bond market.

Growing foreign ownership has been supported by the gradual inclusion of Chinese bonds in the Bloomberg Barclays Global Aggregate Index, which began in April. JP Morgan is also expected to add Chinese government bonds to its emerging market local currency bond index in February.

"It is extremely encouraging to see the Chinese bond market being further opened up to investors globally. There are fewer and fewer solid sovereign credits around ... especially after the European sovereign debt crisis. Global treasuries are one of the safe-haven investment asset classes and adding the diversity from a significant economy like China is welcomed," said Kevin Anderson, head of investments for Asia-Pacific at State Street Global Advisors.