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Chinese bonds: clutching at bamboo shoots

China’s charm offensive with foreign investors is running up against a $9tn block. International investment in the country’s vast onshore bond market accounts for just 1 per cent of the total. A recent yield curve inversion in government debt offers further reason to steer clear.

Normally, rates on longer-dated sovereign bonds exceed those on short, to compensate investors for extra risk. But yields on Chinese five-year debt are higher than 10-year.

Such an anomaly often hints at fears about growth and inflation. In China the drivers appear more varied and less ominous. A bull market supported by monetary stimulus has flipped as Beijing cracks down on the use of borrowed money for investment by raising short-term rates. Technical factors are also at play: five-year bonds are less liquid that 10-year bonds, so price moves can be more extreme.

This is the first time such an inversion has been seen since National Interbank Funding Center records began in 2010. China’s bond market might be the third largest in the world but it is young. Capital restrictions and exclusion from global benchmarks make its bonds a mystery to many.

Enthusiasts point to good yields. Investors can earn 3.6 per cent in five-year Chinese sovereigns, compared to 1.8 per cent in US Treasuries and 0.3 per cent in UK gilts. Quotas and licensing requirements have been lifted, making it easier for foreigners to buy these sovereigns. A new plan, Bond Connect, agreed this week should simplify matters by removing the need for an onshore trading account.

China wants to promote the renminbi as an international currency. But overseas investment in its bonds will remain limited until they are included in a major global index. This is years, not months, away.

Until then, the yields are not high enough given concerns about China’s spiralling debt, its currency weakness and the possibility of two US rate rises this year. Apply a currency hedge on five-year debt and dollar investors earn just 2 per cent a year. China’s bond market may be big, but investors can still afford to ignore it.

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