Aggressive monetary and fiscal easing to fight debt-deflation¹ pressures

19 January 2024

Paula Chan, Senior Portfolio Manager, Fixed Income

Isaac Meng, Portfolio Manager, Fixed Income

In this 2024 outlook, Paula Chan, Senior Portfolio Manager, Fixed Income, and Isaac Meng, Portfolio Manager, Fixed Income, present their baseline views on the key macroeconomic themes that will likely impact China’s bond market in 2024. They also explain why an active China fixed-income strategy should continue generating value for global investors.

China Bond Market: 2023 Recap

Global fixed income markets generally faced another highly volatile year in 2023. Investors maintained a relatively sanguine outlook and were constructive on mainland China assets at the beginning of the period. A view that was based on the country’s reopening and economic recovery theme. Despite this early market optimism, China’s fixed income markets then faced a series of headwinds throughout the year:

Despite a strong rebound at the start of the year, mainland China’s recovery lost steam by the second quarter, with the economy dragged down by further weakness in the property sector, softer consumption amid depressed employment conditions, and deepening deflation. Mainland China’s interest rates remained well-anchored even as global bonds sold off during the summer, while China’s credit sold off and the renminbi (CNY) depreciated against the USD as global sentiment weakened.
US growth/inflation reaccelerated in the middle of 2023 despite the US regional banking crisis earlier in the year, prompting the US Federal Reserve (Fed) to hike rates by 100 basis points to 5.5%. The sell-off in global bonds intensified into the third quarter, as the 10-year US Treasury yield bear steepened by +170 basis points from the April low of 3.3% to eventually breach the 5% handle in October. In the final two months of 2023, the market rout dramatically reversed on cooling inflation and the Fed’s dovish pivot after pausing on further hikes.
Rising geopolitical tensions: 2023 saw the Russia-Ukraine war enter its second year while the Israel-Gaza war broke out, adding further strains to the global system. On the other hand, the mainland China-US geopolitical rivalry appeared to stabilise with both Presidents meeting on the sidelines of the November Asia-Pacific Economic Cooperation (APEC) summit.

Anchored by monetary easing by the People’s Bank of China (PBOC) and rising real yields, driven by low inflation and even deflation, Chinese government bonds (CGBs) enjoyed stable performance throughout 2023. The Bloomberg Aggregate China Total Return (TR) Bond Index gained +2.71% in USD terms over the calendar year 2023.

Chart 1: 2023 market recap – returns in USD

Source: Manulife Investment Management, Bloomberg, as of 31 December 2023. It is not possible to invest directly in an index. Past performance does not guarantee future results. China aggregate TR-unhedged refers to Bloomberg Global Aggregate China TR Index Unhedged, China aggregate TR-FX hedged refers to Bloomberg Global Aggregate China TR Index Hedged, JACI China USD Credit refers to J.P. Morgan China Total Return, US Aggregate refers to Bloomberg US Aggregate Total Return Value Unhedged, Global Agg EX-CNY refers to Bloomberg Global Aggregate Ex-CNY, GBIEM refers to JPMorgan Government Bond Index-Emerging Markets, and GBIEM FX unhedged refers to JPMorgan Government Bond Index-Emerging Markets Unhedged.

Related market moves:

The Bloomberg Global Aggregate China TR Index returned +2.71% in USD terms and +4.79% in local terms during the calendar year 2023.
The CNY depreciated by approximately 2.8% to 7.1 against the USD over the year. On a foreign exchange (FX) hedged basis, China bond aggregate return was boosted to 8.29% due to a pick-up from hedging back to USD, given China onshore rates were lower than US rates.
10-year CGB yields declined by 28 basis points to 2.56% from 2.84% at the beginning of 2023.
JACI China Credit Index returned 3.64% in USD terms over the year. After a strong rally at the beginning of 2023, credit spreads widened in the middle of the year. Economic data worsened before a strong rally, driven mainly by the Fed’s rate pause, to finish in positive territory.
US Treasury yields rallied to close the year at 3.88% after touching 5% in late October. The interest rate differential between 10-year CGBs and 10-year US Treasuries stood at -1.32% at the end of December from -1.03% at the beginning of the year.

2024 macro themes: further policy easing to address deflation and property woes

1. Deflation vs interest rates: a call to re-engage policy easing

Mainland China’s policymakers calibrated their 2024 economic planning at the annual Central Economic Work Conference (CEWC) in December 2023. While no major surprises were announced, the CEWC concluded that economic activity had bottomed and the principal of maintaining stability and promoting high-quality growth would be maintained in 2024. Macro policy will also retain an accommodative stance that was observed in 2H23.

Given the weakening recovery momentum of mainland China’s economy, struggling property sector, and emerging signs of debt-deflation pressure across both local government finance and households, we believe there is a strong case for a more aggressive monetary and fiscal stimulus. We have already seen the Ministry of Finance announce a RMB1 trillion Special CGB issuance in the fourth quarter of 2023 to front-load fiscal support to boost growth while additional financing support and regulatory forbearance can be expected to backstop funding needs of leading property developers and local government financing vehicles (LGFVs) to prevent broader contagion across financial markets.

Despite pressure from the Fed’s aggressive rate hikes and the ensuing impact on the CNY against the USD, the PBOC nevertheless cut its one-year medium-term lending facility (MLF) rates by 10 basis points in June and then by a further 15 basis points in August 2023. The cuts confirmed the PBOC’s intention to ease monetary policy to address negative economic developments. Looking ahead, we expect the PBOC to cut policy rates (such as the reverse repo rate and the one-year MLF rate) by 50 basis points, as the window for more aggressive monetary easing will open in early 2024.

While the Fed is likely to begin cutting rates and end quantitative tightening (QT) as inflation approaches its 2% target in the second half of 2024. The market is currently pricing in five to six rate cuts (25 basis points each) in the second half of 2024. Clearly, with this backdrop, the PBOC will have greater freedom to intensify its monetary easing efforts to cushion the property downturn and counter emerging deflationary pressure. The potential re-coupling or convergence of the Fed and PBOC’s respective monetary policies in the direction of further easing will be an important theme for all asset classes going forward. This will also directly impact the attractiveness of Chinese bond yields versus US bond yields and drive the direction of the CNY.

2. Property sector backstop

Despite a series of demand-side mortgage and property easing policies, as well as the “Three Arrows” policies to support financing for leading private property developers that have already been announced since 4Q22, the slump in the property market has continued to intensify.

Property sales have fallen by around 40% vs pre-Covid levels, while the negative spillover to growth and employment has risen with rising systemic financial risks. The contraction of the property sector has also compounded the debt-deflation pressure on households, LGFV and corporate sectors via the wealth channel and physical land market. These risks are well recognized, and consensus is building within authorities to reduce contagion and tail risks. Discussion of “whitelists for property financing” and “quantitative financing targets for banks” are encouraging signals.

In the current environment, we remain cautious, focusing on selective national privately-owned enterprise (POE) developers with leading sales and state-owned enterprise (SOE) developers that potentially benefit from government ownership and explicit government support will likely to continue to be the main beneficiaries as the property sector continues to consolidate, led by this group of SOEs and POE survivors.

Risks to our baseline view

While the above macro themes constitute our constructive 2024 baseline views, the following potential events also need to be closely monitored and can present possible risks to our baseline views.

1. Policies are insufficient – monetary and fiscal policies and property sector policies are too passive and insufficient to counter debt-deflation pressure.

2. Spreading financial risks – policies fail to contain systemic risks, which spread to LGFV and lower-tier SOEs and banks.

3. Geopolitical events – post-Taiwan’s election development in January 2024 and the US presidential election on 5 November 2024. Both events can potentially increase regional tensions and further damage the US-mainland China relationship.

4. US inflation re-acceleration – The Fed could be forced to resume hikes in this scenario, which would be negative for global fixed income.

Positive 2024 outlook for China bonds: Duration, currency, and credit

To summarise, we maintain a bullish outlook for China’s bond markets in 2024.

We forecast that China’s onshore bonds will provide mid-to-high single-digit returns for investors on a CNY basis, with the PBOC likely to intensify easing measures, including cutting repo rates by 50 basis points. At the same time, the government’s fiscal stance will likely turn moderately expansionary.

Neutral to moderate positive on CNY: the Fed is expected to ease by 75-150 basis points in 2024, and mainland China’s more proactive stimulus should provide a constructive backdrop for CNY assets. Global investors’ underweight positioning in CNY assets appears extreme, and we have already seen bond inflows resume in the fourth quarter of 2023. The CNY is expected to remain stable around 7.15 against the USD in early 2024, then moderately appreciate in the second half of 2024 as mainland China’s stimulus gains traction and the Fed begins its easing cycle, leading to the USD index peaking.

For USD-based investors, 2024 looks promising as a year for tactical allocation to CNY bonds. An allocation to CNY bonds on a FX-hedged basis should add +200bp carry to result in a higher single-digit return. On the other hand, a more tactical FX unhedged CNY allocation could benefit from potential moderate CNY appreciation.

CGBs remain an attractive investment for global/emerging-market fixed-income portfolios.

Mainland China’s economic and policy cycles are divergent and often not synchronised with the US and other G3 (the US, Japan, and euro area) economies. Over the years, CGBs have shown low yield beta or often negative correlation to US/global rates. The deep liquidity of both government bonds and CNY FX makes China onshore bonds scalable and ideal for active allocations by global investors.

After another year of slumping property sales, falling prices and cascading POE developer defaults, policy consensus is forming that stabilisation of the property sector is necessary to achieve solid economic recovery and benign relations. The Politburo has highlighted a three-pillar approach to the housing recovery, including urban rehabilitation, public housing, and building strategic facilities. Potentially drawing a playbook of quantitative easing (QE) from G3 policymakers of past decades, mainland China has the resources (including its sovereign/central bank balance sheet) and tools (monetary and fiscal policies) to support the housing market and avoid cascading financial stress. PBOC’s lending facilities, such as pledged supplementary lending (PSL) and local government special bond issuances, have already been engaged to extend trillions. With respect to onshore credit, we have seen little contagion to non-property and LGFV sectors following the volatility in the property sector. At the same time, investor support for high-quality SOE names remains intact.

Chart 2: CNY vs one-year mainland China-US rate difference

Source: Manulife Investment Management, Bloomberg, as of 31 December 2023. Star refers to the current and end-December data point.

Portfolio positioning

From a positioning perspective, we believe investors can benefit from the following:

Scaling in an overweight duration position. We see value in the belly of the yield curve to add duration both on an outright basis and relative to US/Asian local rates.
CNY stable but with tactical upside: we typically manage CNY exposure on a hedged basis or with a tactical overlay. We will calibrate neutral or long CNY exposure depending on developments in monetary and fiscal policies and the extent of the divergence between the PBOC’s and the Fed’s monetary policies.
For credit, we see attractive valuations for mainland China’s high-quality investment-grade companies. Particularly some rising star candidates in the tech and gaming sectors with improving credit profiles.

Conclusion:

After experiencing extreme volatility in global rates, FX and credit in 2023, we believe China’s bond market should continue to offer moderate total returns but with lower volatility, buoyed by expected moderate policy easing, while mainland China’s divergent macro-policy cycle versus other major economies should continue to make China’s bond market attractive for diversification purposes.

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1 Debt deflation is an economic theory attributed to economist Irving Fisher. The essence of debt deflation is that when prices and wages fall with the price level, but the nominal size of debts and interest payments are fixed, then borrowers face increasing pressure on the ability to repay. This leads to a leap in loan defaults, which in turn can cause bank insolvencies. The commonly assumed danger of debt deflation is that it can lead to a deflationary spiral, as defaulted debts lead to write-downs by banks and other creditors, which constitute a reduction in the overall volume of money and credit in the economy, which spurs further price and debt deflation in a vicious cycle. Investopedia.

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General Risk Disclosure

Funds offered on this platform may invest in equity, fixed income securities, exchange-traded funds, collective investment schemes and/or other instruments, including derivatives, and each of which has its specific investment objective/ policy with its specific features and different risk profile.
Distribution of dividends, the frequency of distribution and the amount/rate of dividends are not guaranteed. Dividend of certain share/unit classes, at the fund or the investment manager’s discretion, may be paid out of capital or gross income while charging / paying all or part of its fees and expenses out of its capital. This amounts to a return or withdrawal of part of an investor’s original investment or from any capital gains attributable to that original investment, and may result in an immediate reduction of the net asset value per share/unit of the respective share/unit classes after the distribution date.
Some funds may invest in bonds or debt securities which may be subject to credit, liquidity, counterparty and market risks.
Some funds may invest in non-investment grade bonds and unrated securities which may be subject to greater credit and liquidity risks, and may be more volatile than higher rated securities. Some funds may invest in investment grade debt securities, which may be subject to ratings downgrades by the rating agencies that may affect the net asset value of the fund.
Some funds may invest in derivative instruments which may involve additional risks. (For example, leverage may cause greater volatility.)
Some funds may make extensive use of derivatives including more complex derivative instruments or strategies to achieve the investment objective, this may give rise to additional exposure in that performance may rise or fall more than it would have done otherwise. In adverse situations, the fund’s use of derivative instruments may become ineffective and the fund may suffer significant losses. The use of derivatives may give rise to leverage, liquidity, counterparty and valuation risks.
Some funds may invest in emerging economies or markets, where special risks, including liquidity, volatility, government policies, taxation, currency, currency repatriation, political and regulatory risks, may be substantially higher than the risks normally associated with more developed economies or markets.
Some funds may invest in securities of small and/or medium sized companies in the relevant markets. This can involve greater risk than is customarily associated with investments in larger and more established companies.
Some funds may invest in a single country/region and/or a particular industry sector which may be concentrated and subject to greater risks than diversified investments in several countries and/or regions and across sectors.
Some funds may invest directly in certain China A shares via the Stock Connect, which may involve risks related to investments via the Stock Connect and Mainland China investment.
Some funds may have significant exposure to Renminbi ("RMB") bonds/equity/assets or emerging markets, which will be subject to debt instrument, credit/counterparty, concentration, liquidity, volatility, currency, tax, economic, foreign exchange/multi-currency conversion, down-grading, regulatory and political risks and these risks could be substantially higher than the risks normally associated with more established markets.
Some funds with significant exposure to RMB bonds/equity/assets may hold a significant portion of assets in deposits if there are not sufficient RMB instruments to invest in. This may adversely affect the funds’ return and performance.
Some funds using Qualified Foreign Institutional Investor (“QFII”) quota to invest directly in debt instruments/shares in Mainland China may be subject to various requirements and restrictions under the laws of Mainland China related to QFII investment and custodial risks.
Some funds are subject to the risks of investing in other funds and the risks relating to asset allocation strategy and/or downside risk management process.
As RMB is not freely convertible, currency conversion is subject to exchange controls and restrictions. There can be no assurance that RMB will not be subject to devaluation. Insufficient amount of RMB for currency conversion or devaluation of RMB could adversely affect the value of investors’ investments in the RMB denominated class(es) of certain funds. The “Dim Sum” bond market is still a relatively small market which is more susceptible to volatility and illiquidity. Due to RMB concentration risk, the value of the funds with substantial RMB exposure may be more volatile than that of a fund having a more diverse portfolio of investments.
Some funds’ performance will be closely tied to the economic, political, regulatory, geopolitical, market, currency or other conditions in the European Economic Area and may be subject to increased liquidity, price, and foreign exchange risk.
Some funds may invest in Russia and some investments in Russian securities may be unlisted securities not dealt on a regulated market. The Russian market presents specific risks in relation to the settlement and safekeeping of securities.
Investment involves risk. Investors may expose to capital loss and should not invest solely based on the information on this website alone and should read the offering documents for details including the associated risk factors, charges and features of the funds and their share/unit classes. Past performance information is not indicative of future performance.

Manulife Global Fund

Manulife Global Fund is an umbrella fund comprising a number of sub-funds investing in equity and/or fixed income securities, each of which has a different investment objective and risk profile and may involve equity market, geographical concentration, sovereign debt, liquidity, volatility, credit downgrade, interest rate, counterparty risks. Certain investors may also be subject to the risk relating to RMB hedged share class.
The relevant distributing class of the sub-funds does not guarantee distribution of dividends, the frequency of distribution and the amount/rate of dividends. Dividends may be paid out of income, realized capital gains and/or out of capital of certain sub-funds in respect of Inc share class(es). Dividends may be paid out of realized capital gains, capital and/or gross income while charging all or part of their fees and expenses to capital (i.e. payment of fees and expenses out of capital) in respect of MDIST (G) and R MDIST (G) share class(es). Dividends paid out of capital of these sub-funds amounts to a return or withdrawal of part of the amount of an investor’s original investment or from any capital gains attributable to that original investment and may result in an immediate decrease in the net asset value per share in respect of such class(es) of the sub-funds.
Certain sub-funds invest in emerging economies or markets, where special risks, including liquidity, volatility, government policies, taxation, currency, currency repatriation, political and regulatory risks, may be substantially higher than the risks normally associated with more developed economies or markets.
Certain sub-funds invest in securities of small and medium sized companies in the relevant markets. This can involve greater risk than is customarily associated with investments in larger and more established companies.
Certain sub-funds concentrate their investments in a single country and/or a particular industry sector are subject to greater risks than diversified investments in several countries and/or regions and across sectors.
Certain sub-funds may invest directly in certain China A shares via Stock Connect, which may involve in risk related to Investments via Stock Connect and Mainland China investment.
Investment involves risk. The sub-funds may expose their investors to capital loss. Investors should not invest solely based on this material and should read the offering document for details including the risk factors, charges and features of the sub-funds and their share classes.
Each sub-fund intends to use financial derivative instruments (“FDIs”) for investment, efficient portfolio management and/or hedging purposes. The use of FDIs exposes the Fund to additional risks, including counterparty/credit risk, liquidity risk, valuation risk, volatility risk and over-the-counter transaction risk.
Given RMB is currently not a freely convertible currency, payment of redemptions and/or dividend payment in RMB may be delayed due to the exchange controls and restrictions applicable to RMB. As offshore RMB (CNH) will be used for the valuation of RMB denominated Class(es), CNH rate may be at a premium or discount to the exchange rate for onshore RMB (CNY) and there may be significant bid and offer spreads and thus the value of the RMB denominated Class(es) will be subject to fluctuation. Any devaluation of RMB could adversely affect the value of investors’ investments in the RMB denominated Class(es) of certain sub-funds.

Manulife Advanced Fund SPC

Manulife Advanced Fund SPC is an umbrella fund comprising a number of sub-funds investing primarily in equity and bond securities, each of which has a different investment objective and risk level.
The sub-funds do not guarantee distribution of dividends, the frequency of distribution, and the amount/rate of dividends. A sub-fund may at its discretion pay dividend out of capital or gross income while charging / paying all or part of its fees and expenses out of its capital. This amounts to a return or withdrawal of part of an investor’s original investment or from any capital gains attributable to that original investment, and may result in an immediate reduction of the net asset value per share of the respective share classes after the distribution date.
Certain sub-funds with significant exposure to Renminbi (“RMB”) bonds/equity/assets or emerging markets, may involve debt instrument, credit/counterparty, concentration, liquidity, volatility, currency, tax, economic, foreign exchange/multi-currency conversion, down-grading, regulatory and political risks and these risks could be substantially higher than the risks normally associated with the world's more established markets.
A bond sub-fund may hold a significant portion of assets in deposits if there are not sufficient RMB instruments for it to invest in. This may adversely affect its return and performance.
Certain sub-funds using invest directly in debt instruments/shares via QFII regime, the Bond Connect and/or the Foreign Access Regime are subject to various requirements and restrictions under the laws of Mainland China related to investment in QFII and/or China Interbank Bond Market and custodial risks.
RMB is not freely convertible and is subject to exchange controls and restrictions.
Certain sub-funds may have significant concentrated exposures to particular industry sectors and geography's, which subjects investors to concentration and equity market risk.
Certain sub-funds may invest in equities of small- and mid-capitalization companies, which can expose investors to liquidity and volatility risks, and is subject to greater risk than is customarily associated with investments in larger capitalization companies.
Investment involves risk. The sub-funds may expose to a high risk of capital loss. Investors should not invest solely based on this material and should read the offering document for details including the risk factors, charges and features of the sub-funds.

Manulife Hong Kong Series

Manulife Hong Kong Series (“the Series”) is an open-ended unit trust comprising a number of funds primarily investing in equities, debt securities, exchange-traded funds and/or collective investment schemes, each of which has a different investment objective and risk level.
The funds do not guarantee distribution of dividends, the frequency of distribution, and the amount/rate of dividends. Dividends may be paid out of capital and/or out of gross income of certain funds in respect of Inc classes, while charging/paying all or part of certain funds’ fees and expenses to/out of capital of certain funds. This represents a return or a withdrawal of part of an investor's original investment amount or capital gain attributable to that amount. Distributions will result in an immediate decrease in the net asset value of the relevant units. Class AA (RMB) Inc Hedged Unit of certain funds is subject to higher distribution risks than other non-hedged unit classes.
Certain funds may involve equity market, emerging markets, Dim Sum bond market, concentration, volatility, liquidity, credit, credit ratings, below investment grade and unrated securities, credit rating downgrading, interest rates, valuation, sovereign debt, unlisted debt securities, political and regulatory, currency, foreign exchange, derivative and structured product, hedging, and distribution risks. Certain investors may also be subject to the risk relating to RMB hedged share class..
Certain funds are subject to the risks of investing in other funds and the risks relating to asset allocation strategy and/or downside risk management process.
Certain fund is subject to the risks relating to investment in exchange traded funds, Strategic and Tactical Asset Rebalancing Strategy (“STARS”), small- and mid-capped companies, convertible bonds and the risks associated with securitised debt instruments and investments in loss-absorption features. Certain fund is a feeder fund that invests all or substantially all of its assets in another collective investment scheme (the “master fund”) and is therefore subject to the risks of investing in the master fund.
Certain fund will not have direct investments other than cash, cash equivalents and financial derivative instruments (such as futures, options and forwards).
Investment involves risk. The funds may expose its investors to capital loss. Investors should not make investment decisions based on this material alone but should read the offering document for details, including the risk factors, charges and features of the Fund and its unit classes.