China dollar credit in a rising rate environment

The start of 2022 has been volatile for fixed income markets given the Fed’s hawkish stance as investors price in a quicker pace of rate hikes to curb soaring inflation. These factors along with the volatile geopolitical situation arising from Russia’s invasion of Ukraine have created the perfect storm. Asian dollar-denominated bonds have seen a drop in value of around 11.2% since July 2021.i The weakness in the offshore renminbi and China’s lackluster economic performance due to its zero-COVID strategy is also contributing to this bearish sentiment.
Source: Bloomberg, J.P. Morgan, data as of 31 May 2022.
With markets pricing in about 250 to 300 basis points of tightening in 2022, risk assets across the board have taken a beating. As the Fed quickens the pace of tapering, dollar-denominated bonds with longer-dated maturities are more likely to suffer. Viewed from this perspective, we believe Asian USD credit is still in a better position than US or European credit both in the investment grade and high yield segments. Given their lower duration profiles, Asia dollar bonds are viewed as being less sensitive to interest rate movements. At the still time, these names can offer higher yields than their developed market counterparts which can further offset the impact of potential rate hikes.
Source: Bloomberg, ICE Bank of America Merrill Lynch, data as of 31 May 2022. Notes: Asia IG: ICE Bank of America Merrill Lynch Asian Dollar Investment Grade Corporate Index, US IG: ICE Bank of America Merrill Lynch US Corporate Index, Europe IG: ICE Bank of America Merrill Lynch Euro Corporate Senior Index, Asia HY: ICE Bank of America Merrill Lynch Asian Dollar High Yield Corporate Index , US HY: ICE Bank of America Merrill Lynch US High Yield Index. Method: Yield (%) is based on Yield to Worst, Duration (Years) is based on Modified Duration to Worst.
Within the Asian dollar credit space, we see potential opportunities in China dollar credit that typically have shorter average maturities as compared to other Asian credit. Based on ICE BofAML data, the average maturity of dollar denominated Chinese investment grade corporate bonds was just under six years in mid-2021, while the aggregate market yield was 2.6%.ii The China dollar credit components of major offshore indices such as the J.P.Morgan Asia Credit Index and ICE BofAML Asian Dollar Index, tend to be relatively shorter duration as compared other Asian names, such as sovereigns or quasi-sovereigns from the Philippines and Indonesia for example.
On top of this, spreads on China dollar denominated bonds have widened a bit more than those of other countries in the region in recent months on the back of the market volatility. The three main reasons being.
- Ongoing weakness in the China property sector has led to a sell-off in high yield bonds that has spilled over into investment grade names. Property developers are still facing challenges which is impacting offshore investor sentiment on China debt overall and causing investors to take more defensive approach to portfolios with exposure to China dollar credit.
- China’s tech sector remains volatile given the looming threat of US de-listing as well as the series of regulatory measures that occurred in the latter half of 2021 aligned with the government’s Common Prosperity polic
- Omicron has been spreading in different part of China and cities have been in lockdown given China’s zero-COVID strategy. This has led to weakness in China macro data since the start of 2022.
Over the medium to long term, we expect the rising rate cycle to have less impact on the Asian credit market given the lower sensitivity to interest rates (compared to other regional credit markets). Asian credit spreads have started to show attractive valuations following the recent selloff and we expect China credit to outperform in the second half of 2022. We also believe China policymakers are likely to enact further policy easing measures in 2H given the weak activity data. We therefore expect growth to rebound in the next six months on the back of our expectations of more policy support and the gradual relaxation in COVID restrictions.
We see opportunities in select higher quality Chinese issuers that have strong fundamentals and a secure financial track record, particularly single A and triple B names that may have underperformed in the first quarter of this year. Among the corporates, stated owned enterprises remain our top picks as they are likely to receive strong government support.
Footnotes
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i
Data on JACI index as at 31st May, 2022.
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ii
Are Chinese corporate bonds presenting opportunities following the Covid-19 sell off?, June 2020, https://www.schroders.com/en/us/insights/fixed-income/are-chinese-corporate-bonds-presenting-an-opportunity-following-the-covid-19-sell-off/