In the land of negative rates, the nation that offers yield, any yield at all, is king of the global bond market.
Donald Trump’s America wears that crown. Disappearing rates from Europe to Asia give the US a virtual monopoly on debt offering a return. Make that about 94% worth of all positive yields out there, based on Bank of America Merrill Lynch figures.
And according to analysts at Zero Hedge, it’s “set to become 100% in the coming days.” This, of course, raises a tantalizing question: where’s China?
Pretty much nowhere. To date, Chinese bonds play an oddly marginal role in global indices despite its status as the second-biggest economy. Global fixed-income circles are particularly devoid of mainland corporate debt.
This needs to change, and fast. It’s tempting to imagine a world in which China’s debt was more readily accessible, if mainland rating companies were ready for prime time and if yield spreads offered accurate appraisals of the state of risk in Asia’s top economic power.
Casinos and the house
Global punters, for starters, could spend a bit less time at mainland casinos. That, after all, is precisely what stock bourses in Shanghai and Shenzhen are. Sure, the house – Xi Jinping’s government – makes investors whole from time to time. But Chinese equities are becoming quite the high-stakes gamble as Donald Trump’s trade war does its worst to global growth.
Investors hungry for yield would surely be rushing into Chinese bonds. It’s a supreme irony that amid the chaos of President Trump’s tariffs, US debt is enjoying a safe-haven bid – not China’s.
Granted, China does have a seriously huge debt market. The onshore market alone is roughly US$13 trillion in size, which is nearly comparable to China’s annual gross domestic product. And, as is often pointed out, China’s post-2008 borrowing binge left the nation with a mountain of public and private debt exceeding $34 trillion.
The problem is access. Earlier this year, Beijing celebrated a financial milestone when global index provider MSCI announced it’s quadrupling the weighting of mainland shares in global stock benchmarks. The step, it’s estimated, could pull at least $80 billion of fresh foreign capital China’s way.
Then came news in April that the Bloomberg Barclays Global Aggregate Index would include yuan bonds, a major boost to China’s role in global debt markets. The index is currently adding 364 onshore mainland bonds, which analysts reckon will woo roughly $150 billion of foreign inflows into the world’s third-largest markets after the US and Japan.
‘Big bang’ moment
UBS Asset Management calls it a “Big bang” moment. And from the standpoint of China’s biggest change agents of the last 20 years, that’s no overstatement. Take Zhu Rongji, premier from 1998 to 2003. He was China’s most important reformer since Deng Xiaoping and a proponent of the “Trojan horse” approach to modernizing the economy.
In 2001, Zhu shepherded Beijing into the World Trade Organization. His hope was that, once inside China’s walls, WTO norms would force the government to liberalize the economy expeditiously and boldly. Think of it as a rearguard attack on the Communist Party’s insularity and inefficiency.
While that didn’t really happen, Zhu’s protégée Zhou Xiaochuan repeated the strategy time and time again, running the People’s Bank of China from 2002 to 2018. That included getting the International Monetary Fund inside China’s walls.
Zhou succeeded in horning Beijing’s way into the IMF’s top-five currencies club. China’s inclusion in IMF’s “special drawing rights” system forces China to open the capital account and increase transparency. It wasn’t easy for Zhou. He had to get President Xi onboard. No easy feat, considering that China Inc’s opacity is a major source of Xi’s control.
Getting China included in the Bloomberg Barclays index and other global benchmarks is a vital step. And it’s stellar news not just for investors but for governments around the globe. China’s rapid rise presents a certain paradox. The world’s second-biggest economy and largest trading nation is also among the most opaque.
That’s a worry considering how the financial crisis of the last 25 years emerged seemingly out of nowhere. The 1994 Mexican crisis went from zero to 60 seemingly overnight. Ditto for Asia’s meltdown three years later. Few genuinely saw the 2008 “Lehman shock” and subprime meltdown coming.
When China hits a wall, it follows, it could be quite the surprise. China Inc’s black-box nature tends to warp credit spreads, yield dynamics and secondary-trading liquidity. The nation’s credit rating system is hardly state of the art.
Add in internet censorship, a media system prizing fealty over investigative reporting and a government that blacklists researchers asking too many questions, China’s debt markets can be quite the mystery.
Foreign involvement is critically important. Bond investors can be an acerbic crowd, more inclined to speak out about their investments than play nice. These are folks who regularly appear on Bloomberg Television, CNBC and Fox Business.
Tensions to work out
They will call out early and often any troubles encountered with transparency, settlement snafus, the identity of counterparties or any erratic policy shifts Beijing throws at markets.
There are tensions that need to be worked out. The massive protests in Hong Kong, for example, could reduce Beijing’s risk tolerance – and slow bond-market internationalization. The extent to which the yuan is embroiled in the trade war could delay market-opening steps. The yuan’s recent declines to 11-year lows massively increase currency-risk concerns.
China needs a serious bonding experience, though. The sooner the better. There’s a perverse incongruity to a whale of an economy – more than double the size of Japan’s – being a minnow in bond-trading terms. The global economy would be a very different place if China’s debt universe were open for business.