KUALA LUMPUR: Government bonds from emerging markets (EM) are becoming increasingly attractive as a result of China’s deflationary impact.
“Capital flows into bonds are expected to remain strong in EM, as the region continues to leverage on the deflationary impact of China’s production,” said Gavekal Capital co-founder and chief executive officer Louis-Vincent Gave during a panel discussion on Macro and Markets: Global Macroeconomics, Local Impacts, at the Khazanah Megatrends Forum yesterday.
Deflation refers to a sustained decrease in the general price level of goods and services, which can have several significant impacts on an economy.
Buying bonds in emerging markets that embrace China’s deflationary impact is appealing due to lower inflation and stable growth. These countries benefit from cheaper imports and stronger industrial output, leading to favourable bond yields and reduced risks for investors.
For the past 30 years, China has had a huge deflationary impact on the world. This impact has become greater, now that the Chinese economy has leapfrogged the West in various industries.
Gave pointed out that in countries like Chile and Saudi Arabia have embraced China’s deflationary impact and investors can consider owning government bonds there.
“On the contrary, it is more risky to own government bonds in countries like the United States, Europe, and Canada, which have set up tariffs and trade barriers on Chinese goods.
“Up until about two months ago, the US dollar had been strong.
“Yet, in this strong dollar environment, we have seen a massive outperformance of government bonds in China, Brazil, Chile, Mexico, Indonesia, along with virtually any other EM, and these have crushed the returns of US Treasuries and German bonds.
“To me, this reflects the simple reality: in a world where EM embrace China, and developed markets reject China, investors would want to buy bonds in EM and avoid this asset class in developed markets,” he said. Moreover, China International Capital Corp Limited (CICC) managing director and chief strategist Miao Yanliang said while the significant divergence between the United States and China may pose challenges, it also presents opportunities for the Asean region.
Miao highlighted that there is a divergence in terms of bond rates and the real economy between the two countries.
“The US 10-year bond rate was at 4% while the Chinese 10-year bond rate was at 2%. 10 years ago, the reverse was true, with the Chinese 10-year bond rate at 4%, and the US 10-year bond rate at 2%.
“With regards to the real economy, historically for the past 10 to 15 years, the Purchasing Managers’ Index of China and United States were highly correlated at 0.7 to 0.8, but for the past five years, the correlation has dropped to 0.2,” he said.
In general, a correlation coefficient close to one or minus one indicates a stronger relationship between two variables. While there is no clear definition of what makes a strong correlation, a coefficient above 0.75 (or below minus 0.75) is considered a high degree of correlation, while one between -0.3 and 0.3 is a sign of weak or no correlation.
Miao opined the main reason for the divergence is that the United States and China are currently in different financial cycles, particularly regarding credit dynamics and the real housing crisis. He added that China has entered into the downcycle of its financial cycle and is deleveraging, while the United States is leveraging up.
“While the current landscape presents challenges, it also offers significant opportunities. The correlation between the United States and China assets used to be moderately correlated at around 0.3%. Nowadays, they barely correlate. However, with the recent uptick in China’s stock market, these assets may start to correlate again. This actually offers a great opportunity for diversification.
“The second major trend is the reconfiguration of globalisation, which has partly contributed to the divergence between the United States and China. In terms of global trade and global investment growth, China has seen a decline of 10 percentage points, but this does not mean China has lost its overall export market share. This is just a reconfiguration of globalisation, which presents new opportunities, particularly for the Asean region,” he said.
Additionally, Miao noted that Malaysia has the potential to play a crucial role in reconnecting global trade, in bridging the gap between global trade and financial systems. To this end, CICC’s Miao expects an increase in cross-border investments between China and the Asean region.
“While finance has changed a lot, global trade still carried on. Globally, we still do a lot of trade with each other, but financial activity has retreated. Typically, trade and finance are components to each other; where financial flows go first followed by trade flows.
“In the next three to five years, there may be a huge trade and finance reconnect, whereby there will be huge investments, be it foreign direct investments or portfolio investment, between China and the Asean region. In the past few years, we have already observed double-digit growth in these areas.
“China is the second-largest economy globally by market value, while Asean ranks fifth. However, we are each other’s top trading partners. This relationship underscores the immense potential for collaboration between China and Asean as we shape the global trade and finance landscape together,” he said.
