China’s bond market surge poses default risk to Wall Street

In the search for yield, the growing corporate bond market in China is the place to go for foreign investors. No emerging market debt has been sexier, according to input data from EPFR Global in Cambridge, Mass. If you were plotting their input charts, your Y-axis numbers would look like Brazil 10, Mexico 10, Russia 12, Turkey 12, China a bazillion.

Guess what happens when these companies fold and Goldman Sachs

and the others hold the bag? Do you think China is bailing them out? Or do you think Washington is bailing them out for buying a Chinese company? I was just thinking out loud. My answer is: not Beijing.

Foreign holdings of Chinese bonds accelerated from 2.96% in September 2020 to 3.2% in December 2020, including quasi-sovereigns issued by Chinese banks.

The numbers seem small as a percentage, but the growing interest from foreign investors is due to China’s aggressive drive to transfer some of its debt risk to foreigners.

Yes, many countries do. China is new. But no major emerging market is being touted as a potential ticking time bomb as much as China.

The Chinese bond market faces a number of structural challenges. The repayment pressure for bond issuers has worsened. Bond defaults have increased, but remain low for an emerging market. China is pretty solid here, which is why big emerging market bond fund managers love them.

However, recent flaws hit big brands like HNA Group. A few highly rated public companies also struggled to repay interest and principal to bondholders. Foreigners now make up a larger part of this risk universe and China can be seen offloading more of these obligations to department stores in emerging markets in London, Tokyo and New York to provide some relief to locals.

The trade war and economic shock caused by the shutdowns in 2020 clearly contributed to bond defaults. Also due to the pandemic, the budgetary situation of local governments was already deteriorating and was being hit harder by the closures. In other words, local government debt and budget deficits seem to go hand in hand with more bond defaults, says Alicia Garcia Herrero, chief economist at Natixis.

While general sentiment towards onshore and offshore bonds has continued to improve among foreign fixed income investors, renewed concerns over China’s defaults are resurfacing. This should remain a problem in 2021, although Natixis thinks it will be obsessed with specific names and sectors.

The bankruptcy of HNA Group may slow some of these flows into Chinese fixed income for the time being.

The recent rebound in US Treasury yields since December 2020 also makes the Chinese bond market somewhat less attractive.

“If we also add the fact that the yuan appreciated quite rapidly against the dollar in 2020, the additional room for appreciation may no longer be there,” says Garcia Herrero.

The narrowing of the tempting interest rate differential between the United States and China and the increase in credit risk are giving investment firms pause. They are not interested in holding the bag for Chinese companies.

Finally, while diversification into global fixed income continues to make China a star, US sanctions against a growing number of Chinese companies will also hurt confidence, possibly holding down bond prices there. relatively stable. And, better yet, make sure that American taxpayers don’t bail out New York investment banks that have sunk tens of millions into Chinese companies they knew little about, but which made a handsome 5% return. in what has been a nearly zero return world. for some time now.

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