A massive budget deficit and annual debt serving costs, combined with the Federal Reserve’s inflationary interest rate stance in the US, contrasts with China’s fiscal and monetary restraint.
The result will be the end of dollarisation, and hence investors can no longer find comfort in the greenback and US Treasury bonds during periods of market distress, according to Davis Hall, head of capital markets Asia, investments and structuring at Indosuez Wealth Management.
“Instead, China government bonds (CGBs) will be the new safe-haven for global investors during the next decade,” Hall told clients and media this week.
Ten-year CGBs offer a 250 basis points yield premium over 10-year US Treasuries, and foreign ownership — in part encouraged by the inclusion of CGBs in major indices — “has only recently started to increase”, according to Hall.
According to China Central Depository and Clearing, foreign holdings of onshore bonds are about RMB2.8trn ($413bn), which is a steady, but not spectacular, increase from about RMB1.8trn in January 2019.
“Foreigners are just waking up to attractive relative real CGB yields and China’s steady policy decisions,” said Hall.
Contrasting policy responses
Meanwhile, China’s central bank — the Peoples Bank of China (PBOC) — will not flood the economy with liquidity, nor move to zero or negative interest rates in order to stimulate the economy.
In fact and in perception, “China is managing the coronavirus pandemic better and recovering faster than anyone else,” Hall said.
In contrast, the US fiscal and monetary response to the pandemic threatens to undermine the reliability and stability of the country’s currency and government bonds.
Most recently, while signalling that there would be no interest rate hikes until at least the end of 2023, the US Federal Reserve yesterday also re-emphasised its average inflation targeting strategy.
It said that policy rates will remain anchored at current levels until inflation has risen to 2% and is on track to moderately exceed that rate for some time.
Some analysts, such as Blackrock’s chief investment officer for global fixed income, Rick Rieder, doubt whether that aim is either achievable or desirable.
They argue that the dis-inflationary influences of technological innovation and the demographic trend of population ageing will dampen price rises, while official attempts to push inflation higher would hurt many lower- to middle-income US households.
However, Indosuez’s Hall is more concerned that the Fed might persist with “too loose monetary policy for too long”.
But, with $700bn (and rising) of annual debt servicing, US policymakers are likely to allow inflation to overshoot in order to repay the costs of its massive pandemic-related fiscal spending.
“Covid-19 could mark the beginning of the end of the deflationary era that started in the 1980s,” he said.
It would also mean the eventual end of dollarisation, and hence US exceptionalism.
“Meanwhile, the renminbi’s performance has been the surprise of the year,” said Hall.
The currency has appreciated 5.5% against the US dollar since its low of RMB 7.16 on 27 May, due to a combination of the relative recovery of the Chinese economy compared with the rest of the world and headwinds for the greenback.
It is now trading at around RMB 6.77, according to Bloomberg data, and Hall believes it could strengthen further.
The PBOC’s current stance is in sharp contrast to a year ago, when the currency broke above the RMB 7 symbolic level, which prompted the US to label Beijing a currency manipulator.
The PBOC responded that the fall was driven by “unilateralism and trade protectionism measures and the imposition of tariff increases on China”.
However, Hall sees a fundamental shift in China’s response to the continuing trade dispute with the US.
“China’s policymakers are set on shifting the country’s economic model with an emphasis on generating internal demand rather than exports, and a strong renminbi reduces China’s commodities import bill,” he said.