More pressure on the renminbi, less on bonds

Chinese bonds’ total return performance in local currency has been vastly superior to that of US Treasuries year to date. But the renminbi’s recent sharp depreciation against the US dollar in parallel with the sharp rise in the 10-year US Treasury yield since the start of the year means Chinese bonds’ performance is negative once converted into US dollars (but still positive in euro).

Increased bond supply coupled with lower demand from foreign investors could push Chinese long-term sovereign bond yields slightly higher in H2, especially if economic growth rebounds as we expect. We see the 10-year Chinese yield moving up from 2.76% (on 27 May) to 3.2% by the end of the year. Higher Chinese yields could then attract foreign investors back if the rate differential with US Treasuries is comfortably positive again and the outlook brightens for the renminbi.

However, a change in the Chinese authorities’ ‘zero-covid’ policy and/or more meaningful stimulus measures may be needed to significantly improve the outlook for the renminbi, while heightened geopolitical tensions with the US remain an issue. Monetary policy divergence with the US is likely to weigh further on the renminbi in the coming months. This could limit monetary policy easing by the People’s Bank of China, leaving fiscal policy to do the heavy lifting as China seeks to restore economic momentum.

Given our less constructive view on the renminbi and our expectations for slightly higher yields, Chinese government bonds look less attractive than before in the current climate. We have thus moved our stance on them from overweight to neutral, bringing it into line with our position on government bonds globally.

Our central scenario is for the USD/CNY rate to stabilise slightly below CNY7.00 in the coming months, in line with a US dollar that remains relatively stable at a high level and a renminbi trade-weighted index that continues to adjust lower. Further out, we see the renminbi rebounding towards CNY6.60 over the next 12 months as the dollar weakens.