Despite a growing economic and technological decoupling between China and the West, the financial divide is actually shrinking. Capital from the U.S. and Europe is flowing into China’s bond market at an unprecedented pace, at least partly due to a search for attractive yield and high quality1 alternatives to U.S. and European bonds.
Trickle, flow, gush
China’s bond market – now the second largest in the world – has seen increased foreign participation, especially in its government bond market, where foreign ownership now exceeds 9%, up from a negligible level just a few years ago.2 The trickle that began in 2014 with a highly controlled quota system turned into a steady inflow after the Chinese government loosened access and China earned inclusion into flagship bond indices. Whether or not this accelerates into an outright gush will depend on the evolving needs of individual investors.
One clear motive behind the influx of capital into China’s bond market is the search for yield. Chinese government bonds yield close to 3%; higher-quality Chinese corporates can yield 4% to 5%.3 With U.S. Treasury yields as low as they now are, some American investors, who have been less aggressive than their European and Japanese peers in searching for yield beyond their domestic market, may step up investments in overseas bond markets.
Many of our clients have another, equally important motive: assets that are negatively correlated with equities. U.S. Treasuries have been used as a bedrock of portfolio construction for more than 30 years, offering not simply diversification but hedge value versus equities: an opportunity for capital gains when equity prices decline. Our colleagues Scott Mather and Anmol Sinha discuss why we believe Treasuries remain a beneficial core component of portfolios in the blog post, “The Role of Bonds in a New Era of Low Yields.”