From moderate policy tightening to easing: China bond market continues to provide opportunities

16 December 2021

Paula Chan, Senior Portfolio Manager, Fixed Income

Isaac Meng, Portfolio Manager, Fixed Income

In this 2022 outlook, Paula Chan, Senior Portfolio Manager, Fixed Income, and Isaac Meng, Portfolio Manager, Fixed Income, outline why they believe China fixed income can continue to benefit from several key drivers.

As we approach the end of 2021, our constructive view on the Chinese onshore bond market at the beginning of the year has played out, despite a generally challenging environment for global fixed income markets due to rising interest rates. Going forward, we believe that China bonds should continue to benefit from several key drivers, namely the call to re-engage policy easing, sustainable currency strength, and their diversification benefits for global investors.

China bonds (based on the Bloomberg Global Aggregate China TR Bond Index) have outperformed other major bond categories, gaining +6.99% over the year to date – as of 30 November 2021, in US dollar (USD) terms. (see Chart 1).

Chart 1: Major bond market returns in 2021

Source: Bloomberg, data as of 30 November 2021. Past performance does not guarantee future results. It is not possible to invest directly in an index.

Related market moves:

The Bloomberg Global Aggregate China TR Index has returned +4.2% in local terms (YTD to 30 November)
The onshore renminbi (CNY) has appreciated by approximately +2.6% to 6.36 against the USD over the same period.
Chinese government bond (CGB) 10-year yields declined by 28 basis points (bps) to 2.86% from the beginning of 2021 to the end of November 2021
As US Treasury yields increased, the premium or yield pick-up in 10-year CGBs versus US Treasuries also narrowed by 81 bps to 1.42%.

China bond premium can attract yield-seeking investors

The strong absolute and relative performance of Chinese bonds in 2021 can be attributed to the Chinese government maintaining a tighter monetary and fiscal stance that has helped CGBs retain an attractive yield level relative to other global government bond yields. Since the pandemic began in the first half of 2020, the People’s Bank of China (PBOC) has cut the 7-day reverse repo rate by only 30 bps to 2.2%. Unlike many global peers, the PBOC has refrained from implementing quantitative easing and has, therefore, preserved the capacity or policy room to ease monetary policy at a later stage. Accordingly, CGBs stand out with the bond curve offering a positive yield spread of between 150-200 bps above G7 sovereign bonds, given policy rates for G7 countries are negative or zero-bound with deeply negative real bond yields.

The changing shape of monetary and fiscal policies

In terms of fiscal policy, China is the only major economy in the G20¹ to meaningfully tighten in 2021. Over the year, China’s fiscal impulse turned to -2.5% of GDP. The net issuance of government bonds (CGBs, local government financing, policy bank) declined by CNY 2.8 trillion over the first three quarters and is expected to be around CNY 2.4 trillion less than 2020 overall². Moderate fiscal tightening has capped domestic demand and prices, while lower bond supplies have helped flatten the long end of the yield curve.

On the currency front, the CNY has appreciated by +2.6% against the USD and +8.3% against the CFETS currency basket, which measures CNY value against a trade-weighted basket of foreign currencies. The strength of the CNY has been underpinned by China’s record trade surplus of over US$650 billion as China’s economy benefitted from its resilient industrial supply chains, which have helped mitigate stagflation headwinds.

Overall, we think both China bonds and the CNY remain attractive given the above factors with ample risk-premium attached to China local bonds and the currency.

2022 macro themes: Policy easing, impact of COVID developments, and US rate normalisation

Looking ahead to 2022, we will closely watch the following three key macro themes and their implications.

1. Weakening of Chinese domestic demand: A call to re-engage policy easing

Chinese policymakers calibrated the 2022 economic planning at the annual Central Economic Work Conference on 10^th December, where GDP growth and inflation targets, monetary policy, and fiscal budget objectives were agreed upon. We believe that sustaining a benign macro environment with stable growth and financial stability will be paramount ahead of the 20^th Party Congress due to be held in the second half of 2022. The Party Congress is held every five years and is responsible for formally approving the membership of the Central Committee, which comprises the top leaders of the Communist Party of China.

Given the weaker economic data experienced in the second half of 2021, we believe there is a strong case for some moderate loosening of China’s monetary and fiscal stance, while additional credit and regulatory easing can be expected to provide relief to cushion the impact of the downturn in the property sector on the broader Chinese economy.

On 6^th December, the PBOC made a broad-based 50 bps cut in the reserve requirement ratio (RRR) as widely expected by the market after the recent speech by Premier Li when he indicated that the RRR would be cut to support the real economy amid increasing signs of downside risk. According to the central bank, this will unlock CNY 1.2 trillion of long-term funding. We see the move as a clear sign of policy easing to address negative developments in the economy, while further monetary easing can still be expected in early 2022.

Chart 2: China government bonds stands out with positive yield spread

Source: Bloomberg, data as of 30 November 2021. Past performance does not guarantee future results. It is not possible to invest directly in an index.

2. COVID developments: The Omicron variant and evolution of pandemic stagflation supply shocks

While we are close to two years into the pandemic, there are still no signs of a clear ending in sight. Recently, risk markets have been roiled by the discovery of the Omicron variant and the uncertainty surrounding its impact on global growth. Economic data for the Chinese economy remains lacklustre, and a deeper pandemic could result in further stagflation supply shocks that would have important consequences on investors’ risk appetites and could drive their exposure to Chinese bonds in the short term.

3. Interest rate normalisation: An exit of pandemic stimulus, Fed tapering, and the path to higher rates

The Fed has proactively signalled its intention to increase the speed of tapering to exit its pandemic stimulus while the market is also currently pricing in two 25 bps rate hikes in the second half of 2022. Clearly, this will be an important theme for all asset classes and directly impact the attractiveness of Chinese bond yields versus US bond yields and determine the relative value of the CNY against the USD.

Our outlook for 2022: Duration, currency, and credit

To summarise, our baseline 2022 outlook for China bonds is as follows:

We think China onshore bonds are projected to provide low- to mid-single-digit returns for investors, with the PBOC to take moderate easing measures, including cutting repo rates by 10-20 bps. At the same time, the government’s fiscal stance will likely turn moderately expansionary.
Due to the increasing divergence in global macro-policy cycles, we expect China onshore bonds to maintain their low correlation to other fixed income markets and continue to provide potential diversification benefits for global fixed income portfolios.
CNY strength could continue into early 2022 due to China maintaining an elevated trade surplus, while foreign investor flows into onshore bonds remain strong. The strength of the CNY should also help create a window for the PBOC to ease monetary policy even when the Fed is embarking on a gradual interest rate normalisation.
Given the importance of the property sector as a key driver to China’s GDP growth, we believe the government will be cautious to avoid triggering a macro hard landing while continuing to reform the sector. We think the government has enough tools to stimulate this sector and ensure the non-real-estate segment remains intact, such as tax cuts for SMEs, PBOC’s lending facilities, and local government special bond issuances. With respect to onshore credit, we have seen very little contagion to non-property sectors following the volatility in the property sector while investor support for high quality SOE names remains in-tact.

From a positioning perspective, we believe investors can benefit from the following:

There is value in the intermediate and long-end of the yield curve to add duration both on an outright basis and relative to US rates.
We expect the CNY to remain relatively stable against the USD in the near term, as the currency should be anchored by a strong balance of payment flows. For portfolios where the CNY exposure is actively managed, this will be calibrated depending on developments related to COVID and on the extent of the divergence between PBOC and Fed monetary policies.
For credit, we see attractive valuations for high-quality names after the recent sell-off in September and October 2021 due to the volatility in the property sector.

To conclude, China bonds are expected to remain attractive in 2022, buoyed by potential moderate policy easing, China’s divergent macro-policy cycle versus other major economies, as well as sustainable strength in the CNY which has been supported by China’s elevated trade surplus and persistent investor inflows.

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¹Manulife Investment Management, as of December 2021.

² WIND, Manulife Investment Management, as of December 2021.

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Some funds may invest directly in certain China A shares via the Stock Connect, which may involve risks related to investments via the Stock Connect and Mainland China investment.
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Some funds’ performance will be closely tied to the economic, political, regulatory, geopolitical, market, currency or other conditions in the European Economic Area and may be subject to increased liquidity, price, and foreign exchange risk.
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Certain sub-funds invest in emerging economies or markets, where special risks, including liquidity, volatility, government policies, taxation, currency, currency repatriation, political and regulatory risks, may be substantially higher than the risks normally associated with more developed economies or markets.
Certain sub-funds invest in securities of small and medium sized companies in the relevant markets. This can involve greater risk than is customarily associated with investments in larger and more established companies.
Certain sub-funds concentrate their investments in a single country and/or a particular industry sector are subject to greater risks than diversified investments in several countries and/or regions and across sectors.
Certain sub-funds may invest directly in certain China A shares via Stock Connect, which may involve in risk related to Investments via Stock Connect and Mainland China investment.
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Given RMB is currently not a freely convertible currency, payment of redemptions and/or dividend payment in RMB may be delayed due to the exchange controls and restrictions applicable to RMB. As offshore RMB (CNH) will be used for the valuation of RMB denominated Class(es), CNH rate may be at a premium or discount to the exchange rate for onshore RMB (CNY) and there may be significant bid and offer spreads and thus the value of the RMB denominated Class(es) will be subject to fluctuation. Any devaluation of RMB could adversely affect the value of investors’ investments in the RMB denominated Class(es) of certain sub-funds.

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Manulife Advanced Fund SPC is an umbrella fund comprising a number of sub-funds investing primarily in equity and bond securities, each of which has a different investment objective and risk level.
The sub-funds do not guarantee distribution of dividends, the frequency of distribution, and the amount/rate of dividends. A sub-fund may at its discretion pay dividend out of capital or gross income while charging / paying all or part of its fees and expenses out of its capital. This amounts to a return or withdrawal of part of an investor’s original investment or from any capital gains attributable to that original investment, and may result in an immediate reduction of the net asset value per share of the respective share classes after the distribution date.
Certain sub-funds with significant exposure to Renminbi (“RMB”) bonds/equity/assets or emerging markets, may involve debt instrument, credit/counterparty, concentration, liquidity, volatility, currency, tax, economic, foreign exchange/multi-currency conversion, down-grading, regulatory and political risks and these risks could be substantially higher than the risks normally associated with the world's more established markets.
A bond sub-fund may hold a significant portion of assets in deposits if there are not sufficient RMB instruments for it to invest in. This may adversely affect its return and performance.
Certain sub-funds using invest directly in debt instruments/shares via QFII regime, the Bond Connect and/or the Foreign Access Regime are subject to various requirements and restrictions under the laws of Mainland China related to investment in QFII and/or China Interbank Market and custodial risks.
RMB is not freely convertible and is subject to exchange controls and restrictions.
Certain sub-funds may have significant concentrated exposures to particular industry sectors and geography's, which subjects investors to concentration and equity market risk.
Certain sub-funds may invest in equities of small- and mid-capitalization companies, which can expose investors to liquidity and volatility risks, and is subject to greater risk than is customarily associated with investments in larger capitalization companies.
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Manulife Hong Kong Series (“the Series”) is an open-ended unit trust comprising a number of funds primarily investing in equities, debt securities, exchange-traded funds and/or collective investment schemes, each of which has a different investment objective and risk level.
The funds do not guarantee distribution of dividends, the frequency of distribution, and the amount/rate of dividends. Dividends may be paid out of capital and/or out of gross income of certain funds in respect of Inc classes, while charging/paying all or part of certain funds’ fees and expenses to/out of capital of certain funds. This represents a return or a withdrawal of part of an investor's original investment amount or capital gain attributable to that amount. Distributions will result in an immediate decrease in the net asset value of the relevant units. Class AA (RMB) Inc Hedged Unit of certain funds is subject to higher distribution risks than other non-hedged unit classes.
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As RMB is not freely convertible, currency conversion is subject to exchange controls, and restrictions. There can be no assurance that RMB will not be subject to devaluation. Insufficient amount of RMB for currency conversion or devaluation of RMB could adversely affect the value of investors’ investments in the RMB denominated class(es) of certain funds. The “Dim Sum” bond market is still a relatively small market which is more susceptible to volatility and illiquidity. Due to RMB concentration risk, the value of the funds may be more volatile than that of a fund having a more diverse portfolio of investments.
Certain fund will not have direct investments other than cash, cash equivalents and financial derivative instruments (such as futures, options and forwards).
Investment involves risk. The funds may expose its investors to capital loss. Investors should not make investment decisions based on this material alone but should read the offering document for details, including the risk factors, charges and features of the Fund and its unit classes.

General Risk Disclosure

Funds offered on this platform may invest in equity, fixed income securities, exchange-traded funds, collective investment schemes and/or other instruments, including derivatives, and each of which has its specific investment objective/ policy with its specific features and different risk profile.
Distribution of dividends, the frequency of distribution and the amount/rate of dividends are not guaranteed. Dividend of certain share/unit classes, at the fund or the investment manager’s discretion, may be paid out of capital or gross income while charging / paying all or part of its fees and expenses out of its capital. This amounts to a return or withdrawal of part of an investor’s original investment or from any capital gains attributable to that original investment, and may result in an immediate reduction of the net asset value per share/unit of the respective share/unit classes after the distribution date.
Some funds may invest in bonds or debt securities which may be subject to credit, liquidity, counterparty and market risks.
Some funds may invest in non-investment grade bonds and unrated securities which may be subject to greater credit and liquidity risks, and may be more volatile than higher rated securities. Some funds may invest in investment grade debt securities, which may be subject to ratings downgrades by the rating agencies that may affect the net asset value of the fund.
Some funds may invest in derivative instruments which may involve additional risks. (For example, leverage may cause greater volatility.)
Some funds may make extensive use of derivatives including more complex derivative instruments or strategies to achieve the investment objective, this may give rise to additional exposure in that performance may rise or fall more than it would have done otherwise. In adverse situations, the fund’s use of derivative instruments may become ineffective and the fund may suffer significant losses. The use of derivatives may give rise to leverage, liquidity, counterparty and valuation risks.
Some funds may invest in emerging economies or markets, where special risks, including liquidity, volatility, government policies, taxation, currency, currency repatriation, political and regulatory risks, may be substantially higher than the risks normally associated with more developed economies or markets.
Some funds may invest in securities of small and/or medium sized companies in the relevant markets. This can involve greater risk than is customarily associated with investments in larger and more established companies.
Some funds may invest in a single country/region and/or a particular industry sector which may be concentrated and subject to greater risks than diversified investments in several countries and/or regions and across sectors.
Some funds may invest directly in certain China A shares via the Stock Connect, which may involve risks related to investments via the Stock Connect and Mainland China investment.
Some funds may have significant exposure to Renminbi ("RMB") bonds/equity/assets or emerging markets, which will be subject to debt instrument, credit/counterparty, concentration, liquidity, volatility, currency, tax, economic, foreign exchange/multi-currency conversion, down-grading, regulatory and political risks and these risks could be substantially higher than the risks normally associated with more established markets.
Some funds with significant exposure to RMB bonds/equity/assets may hold a significant portion of assets in deposits if there are not sufficient RMB instruments to invest in. This may adversely affect the funds’ return and performance.
Some funds using Qualified Foreign Institutional Investor (“QFII”) quota to invest directly in debt instruments/shares in Mainland China may be subject to various requirements and restrictions under the laws of Mainland China related to QFII investment and custodial risks.
Some funds are subject to the risks of investing in other funds and the risks relating to asset allocation strategy and/or downside risk management process.
As RMB is not freely convertible, currency conversion is subject to exchange controls and restrictions. There can be no assurance that RMB will not be subject to devaluation. Insufficient amount of RMB for currency conversion or devaluation of RMB could adversely affect the value of investors’ investments in the RMB denominated class(es) of certain funds. The “Dim Sum” bond market is still a relatively small market which is more susceptible to volatility and illiquidity. Due to RMB concentration risk, the value of the funds with substantial RMB exposure may be more volatile than that of a fund having a more diverse portfolio of investments.
Some funds’ performance will be closely tied to the economic, political, regulatory, geopolitical, market, currency or other conditions in the European Economic Area and may be subject to increased liquidity, price, and foreign exchange risk.
Some funds may invest in Russia and some investments in Russian securities may be unlisted securities not dealt on a regulated market. The Russian market presents specific risks in relation to the settlement and safekeeping of securities.
Investment involves risk. Investors may expose to capital loss and should not invest solely based on the information on this website alone and should read the offering documents for details including the associated risk factors, charges and features of the funds and their share/unit classes. Past performance information is not indicative of future performance.

Manulife Global Fund

Manulife Global Fund is an umbrella fund comprising a number of sub-funds investing in equity and/or fixed income securities, each of which has a different investment objective and risk profile and may involve equity market, geographical concentration, sovereign debt, liquidity, volatility, credit downgrade, interest rate, counterparty risks.
The relevant distributing class of the sub-funds does not guarantee distribution of dividends, the frequency of distribution and the amount/rate of dividends. Dividends may be paid out of income, realized capital gains and/or out of capital of certain sub-funds in respect of Inc share class(es). Dividends may be paid out of realized capital gains, capital and/or gross income while charging all or part of their fees and expenses to capital (i.e. payment of fees and expenses out of capital) in respect of MDIST (G) and R MDIST (G) share class(es). Dividends paid out of capital of these sub-funds amounts to a return or withdrawal of part of the amount of an investor’s original investment or from any capital gains attributable to that original investment and may result in an immediate decrease in the net asset value per share in respect of such class(es) of the sub-funds.
Certain sub-funds invest in emerging economies or markets, where special risks, including liquidity, volatility, government policies, taxation, currency, currency repatriation, political and regulatory risks, may be substantially higher than the risks normally associated with more developed economies or markets.
Certain sub-funds invest in securities of small and medium sized companies in the relevant markets. This can involve greater risk than is customarily associated with investments in larger and more established companies.
Certain sub-funds concentrate their investments in a single country and/or a particular industry sector are subject to greater risks than diversified investments in several countries and/or regions and across sectors.
Certain sub-funds may invest directly in certain China A shares via Stock Connect, which may involve in risk related to Investments via Stock Connect and Mainland China investment.
Investment involves risk. The sub-funds may expose their investors to capital loss. Investors should not invest solely based on this material and should read the offering document for details including the risk factors, charges and features of the sub-funds and their share classes.
Each sub-fund intends to use financial derivative instruments (“FDIs”) for investment, efficient portfolio management and/or hedging purposes. The use of FDIs exposes the Fund to additional risks, including counterparty/credit risk, liquidity risk, valuation risk, volatility risk and over-the-counter transaction risk.
Given RMB is currently not a freely convertible currency, payment of redemptions and/or dividend payment in RMB may be delayed due to the exchange controls and restrictions applicable to RMB. As offshore RMB (CNH) will be used for the valuation of RMB denominated Class(es), CNH rate may be at a premium or discount to the exchange rate for onshore RMB (CNY) and there may be significant bid and offer spreads and thus the value of the RMB denominated Class(es) will be subject to fluctuation. Any devaluation of RMB could adversely affect the value of investors’ investments in the RMB denominated Class(es) of certain sub-funds.

Manulife Advanced Fund SPC

Manulife Advanced Fund SPC is an umbrella fund comprising a number of sub-funds investing primarily in equity and bond securities, each of which has a different investment objective and risk level.
The sub-funds do not guarantee distribution of dividends, the frequency of distribution, and the amount/rate of dividends. A sub-fund may at its discretion pay dividend out of capital or gross income while charging / paying all or part of its fees and expenses out of its capital. This amounts to a return or withdrawal of part of an investor’s original investment or from any capital gains attributable to that original investment, and may result in an immediate reduction of the net asset value per share of the respective share classes after the distribution date.
Certain sub-funds with significant exposure to Renminbi (“RMB”) bonds/equity/assets or emerging markets, may involve debt instrument, credit/counterparty, concentration, liquidity, volatility, currency, tax, economic, foreign exchange/multi-currency conversion, down-grading, regulatory and political risks and these risks could be substantially higher than the risks normally associated with the world's more established markets.
A bond sub-fund may hold a significant portion of assets in deposits if there are not sufficient RMB instruments for it to invest in. This may adversely affect its return and performance.
Certain sub-funds using invest directly in debt instruments/shares via QFII regime, the Bond Connect and/or the Foreign Access Regime are subject to various requirements and restrictions under the laws of Mainland China related to investment in QFII and/or China Interbank Market and custodial risks.
RMB is not freely convertible and is subject to exchange controls and restrictions.
Certain sub-funds may have significant concentrated exposures to particular industry sectors and geography's, which subjects investors to concentration and equity market risk.
Certain sub-funds may invest in equities of small- and mid-capitalization companies, which can expose investors to liquidity and volatility risks, and is subject to greater risk than is customarily associated with investments in larger capitalization companies.
Investment involves risk. The sub-funds may expose to a high risk of capital loss. Investors should not invest solely based on this material and should read the offering document for details including the risk factors, charges and features of the sub-funds.

Manulife Hong Kong Series

Manulife Hong Kong Series (“the Series”) is an open-ended unit trust comprising a number of funds primarily investing in equities, debt securities, exchange-traded funds and/or collective investment schemes, each of which has a different investment objective and risk level.
The funds do not guarantee distribution of dividends, the frequency of distribution, and the amount/rate of dividends. Dividends may be paid out of capital and/or out of gross income of certain funds in respect of Inc classes, while charging/paying all or part of certain funds’ fees and expenses to/out of capital of certain funds. This represents a return or a withdrawal of part of an investor's original investment amount or capital gain attributable to that amount. Distributions will result in an immediate decrease in the net asset value of the relevant units. Class AA (RMB) Inc Hedged Unit of certain funds is subject to higher distribution risks than other non-hedged unit classes.
Certain funds may involve equity market, emerging markets, Dim Sum bond market, concentration, volatility, liquidity, credit, credit ratings, below investment grade and unrated securities, credit rating downgrading, interest rates, valuation, sovereign debt, unlisted debt securities, political and regulatory, currency, foreign exchange, derivative and structured product, hedging, and distribution risks.
Certain funds are subject to the risks of investing in other funds and the risks relating to asset allocation strategy and/or downside risk management process.
Certain fund is subject to the risks of investing in other funds and the risks relating to investment in exchange traded funds, Strategic and Tactical Asset Rebalancing Strategy (“STARS”), small- and mid-capped companies, convertible bonds and the risks associated with securitised debt instruments and investments in loss-absorption features. Certain fund is a feeder fund that invests all or substantially all of its assets in another collective investment scheme (the “master fund”) and is therefore subject to the risks of investing in the master fund.
As RMB is not freely convertible, currency conversion is subject to exchange controls, and restrictions. There can be no assurance that RMB will not be subject to devaluation. Insufficient amount of RMB for currency conversion or devaluation of RMB could adversely affect the value of investors’ investments in the RMB denominated class(es) of certain funds. The “Dim Sum” bond market is still a relatively small market which is more susceptible to volatility and illiquidity. Due to RMB concentration risk, the value of the funds may be more volatile than that of a fund having a more diverse portfolio of investments.
Certain fund will not have direct investments other than cash, cash equivalents and financial derivative instruments (such as futures, options and forwards).
Investment involves risk. The funds may expose its investors to capital loss. Investors should not make investment decisions based on this material alone but should read the offering document for details, including the risk factors, charges and features of the Fund and its unit classes.