Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Rising China opening its markets to the world
Steen Jakobsen
Chief Investment Officer
Summary: China has always been a major power, but its relative ascent versus the US and Europe is steepening, and Beijing's efforts to open its markets to global investors will only further this trend.
It’s ironic to talk about a country ‘growing up’ when it is 4,000 years old and the only country that has consistently retained major-power status. China’s role in the world, however, is on the rise again and to an extent that makes it a heavyweight in capital markets, where it has been “offline” since open markets started in the 1970s, post-Bretton Woods.
This is now changing fast with Stock Connect, Bond Connect and multiple other ways of opening the Chinese economy to inflow and foreign participation in its capital markets.
There are many ways to measure a country’s success and rise – the most common are economic numbers like GDP per capita, overall GDP or productivity, and by those measures China is a stunning success and one that has created great admiration and enormous global trade flows.
This is now changing fast with Stock Connect, Bond Connect and multiple other ways of opening the Chinese economy to inflow and foreign participation in its capital markets.
There are many ways to measure a country’s success and rise – the most common are economic numbers like GDP per capita, overall GDP or productivity, and by those measures China is a stunning success and one that has created great admiration and enormous global trade flows.
These two charts show China’s enormous leap forward since the 1980s; the more relevant measure for now, though, is the chart on the right – China’s share of global GDP is close to 20% and through credit impulse and indirect effects, we at Saxo now estimate China as the single biggest component of global growth with a 40% weight in global net flow and credit.
In other words, it’s more important to monitor the net changes to Chinese credit and fiscal policies than it is to follow the US’ lead (which most of us grew up with and were trained to follow).
There is, however, another key bellwether for a country’s success, impact and sophistication, and that’s the size of its capital markets and access to same. In “Capital Markets – An engine for economic growth”, Geert Bekaert of Stanford University and Campell R. Harvey of Duke University write:
“Economic growth in a modern economy hinges on efficient financial sector which pools domestic savings and mobilizes foreign capital for productive investments. Without an effective set of financial institutions, productive project may remain unexploited”.
The globalisation of markets since the Berlin Wall’s fall in 1989 and China’s inclusion in the World Trade Organization in 2001 have made this argument more valid and true.
China’s role in the asset allocation world is improving fast through a number of channels, with Bond Connect being one of the newest ones. Global asset allocation to Chinese markets is less than 10% of the total, with the US at more than 50%. Bridgewater’s report, entitled “The shift to Chinese assets is beginning”, expects China’s share of global assets to increase to 30% over the next decade while the US’ share should drop to 40%.
This is all based on China continuing to improve domestic infrastructure for bonds, but also allowing bigger and broader access to Chinese markets. The number of changes over the last few years is inarguably impressive:
In other words, it’s more important to monitor the net changes to Chinese credit and fiscal policies than it is to follow the US’ lead (which most of us grew up with and were trained to follow).
There is, however, another key bellwether for a country’s success, impact and sophistication, and that’s the size of its capital markets and access to same. In “Capital Markets – An engine for economic growth”, Geert Bekaert of Stanford University and Campell R. Harvey of Duke University write:
“Economic growth in a modern economy hinges on efficient financial sector which pools domestic savings and mobilizes foreign capital for productive investments. Without an effective set of financial institutions, productive project may remain unexploited”.
The globalisation of markets since the Berlin Wall’s fall in 1989 and China’s inclusion in the World Trade Organization in 2001 have made this argument more valid and true.
China’s role in the asset allocation world is improving fast through a number of channels, with Bond Connect being one of the newest ones. Global asset allocation to Chinese markets is less than 10% of the total, with the US at more than 50%. Bridgewater’s report, entitled “The shift to Chinese assets is beginning”, expects China’s share of global assets to increase to 30% over the next decade while the US’ share should drop to 40%.
This is all based on China continuing to improve domestic infrastructure for bonds, but also allowing bigger and broader access to Chinese markets. The number of changes over the last few years is inarguably impressive:
There is ample reason for investors to increase exposure to Chinese assets. China’s business cycle is often asynchronic to the rest of the world, as was seen during crisis in 2007-09 where China expanded its fiscal deficit massively as world stock markets tanked. Similarly, in 2015-17 China initiated a structural deleveraging of the shadow economy while the US and Europe were in full quantitative easing mode and supporting business and activities through lower interest rates for longer.
This offers major diversification from a cycle perspective even without considering the increasing relative size of the Asian market. There are 7 billion people on the earth today, and 4.5bn of them live in Asia.
We all know the story of “if I could only sell a bicycle to everyone in in China…”
This offers major diversification from a cycle perspective even without considering the increasing relative size of the Asian market. There are 7 billion people on the earth today, and 4.5bn of them live in Asia.
We all know the story of “if I could only sell a bicycle to everyone in in China…”
Saxo’s entry into Bond Connect is well-timed as China has engaged in a major easing of its monetary policy with increased support to housing and corporate bonds.
Significant policy easing generally leads to an increase in the credit flow, and through this better economic data. The profile of the current easing effort is sizeable and, again, countercyclical to the US Federal Reserve in particular. This can be used by global allocators to time and hedge exposure globally. Another angle along which Bond Connect can work is to increase the transmission of credit; partly by sharing the burden of credit facilitation, partly by moving from an overly shadow banking-dependent or (or non-bank lending-dependent) model.
The Credit Impulse is now pointing north again and the scale of the change to shadow banking is obvious from this chart. Remember: Bond Connect and better-functioning, accessible markets are responses from – are deliberate structural changes by – Chinese authorities to improve credit transmission and create more transparency and liquidity.
China is a global power in every aspect save that of a global reservoir for investors (with capital markets commensurate with its size). There is a need for China to become a deposit base and an alternative to Europe and the US as its global role increases. It must be noted as well that any aspiration to attain reserve currency status needs to come with more open capital accounts and increased access to financial markets.
China is clearly determined, and is acting on this. Bond Connect opens up a market that is deep, diverse and attractive. China’s bond market represents only 73% of its GDP, where Japan sits at 336% and the UK at 207%.
China is a global power in every aspect save that of a global reservoir for investors (with capital markets commensurate with its size). There is a need for China to become a deposit base and an alternative to Europe and the US as its global role increases. It must be noted as well that any aspiration to attain reserve currency status needs to come with more open capital accounts and increased access to financial markets.
China is clearly determined, and is acting on this. Bond Connect opens up a market that is deep, diverse and attractive. China’s bond market represents only 73% of its GDP, where Japan sits at 336% and the UK at 207%.
China’s rise is certain, but its ability to continue growing will hinge on better and deeper capital markets for all of the reasons noted above. In a global world, and despite all the pushback seen from populist movements, competing for capital is the game to play. China will do well on this front as its starting position is “modest” – less than 5% of MSCI global equity weight, the third-largest bond market, the fourth- and seventh-largest exchanges in Shanghai and Shenzhen, and a market that is growing fast and that increasingly uses bonds to finance investments.
We are confident that China will build on its recent history and continue to reform and open up. We believe it’s paramount for our clients and friends to realise how small global Chinese allocation actually is, and how big it can and will become. This is a long-term trend that we believe to be irreversible, and as such we look forward to facilitating China’s bond connect with our partners.
We are confident that China will build on its recent history and continue to reform and open up. We believe it’s paramount for our clients and friends to realise how small global Chinese allocation actually is, and how big it can and will become. This is a long-term trend that we believe to be irreversible, and as such we look forward to facilitating China’s bond connect with our partners.
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