The enthusiasm of international funds to raise funds in China's stock market is high. After only 6 trading days in January, northbound funds poured in 33.52 billion yuan.

According to a reporter from China Business News, many institutions have expressed their willingness to increase their positions in the Chinese stock market, especially hedge funds with short assessment periods and strong speculative interests.

  However, compared with the high popularity of China's stock market, the feedback from international institutions on China's bond market is somewhat flat.

The latest data shows that as of November 2022, overseas institutional investors have sold Chinese bonds for 10 consecutive months, with a sales volume of 740 billion yuan, the longest period on record.

The Fed's interest rate hike, the appreciation of the U.S. dollar, and the widening inversion of the China-U.S. interest rate differential have all intensified the selling pressure on the Chinese bond market in 2022, and the attractiveness of high interest rates on U.S. treasury bonds has continued to strengthen.

Will this pattern change in 2023?

Selling pressure on China's bond market expected to ease

  At the end of November 2022, the inter-bank market bonds held by foreign institutions reached 3.33 trillion yuan.

In that month, the proportion of Chinese government bonds held by foreign investors was still as high as 9.1%, down 0.3 percentage points from the previous month.

  But institutions expect inflows ahead, reflecting improved prospects for duration and renminbi exchange rate returns.

"We believe that although large-scale net inflows are unlikely in the short term, the time for large-scale capital outflows has passed." Barclays macro and foreign exchange strategist Zhang Meng told reporters earlier.

  First, the outlook for exchange rates has improved.

For the whole year of 2022, the RMB will depreciate by 7.86% against the US dollar.

On the afternoon of January 9, 2023, the onshore renminbi and offshore renminbi rose more than 600 points against the US dollar within a day.

As of 16:30 Beijing time on the 10th, the onshore RMB closed at 6.7772 against the US dollar at 16:30, down 60 basis points from the previous trading day.

On the 10th, the RMB against the US dollar was still trading in the range of 6.7.

  The "FedWatch Tool" shows that the probability of a rate hike of only 25 basis points (BP) in February is around 75%.

Although the Fed believes that it will not cut interest rates this year, there are still predictions of rate cuts in the second half of the year in the interest rate market.

There are various signs that the Fed's tightening cycle is drawing to a close, and a shift in monetary policy is coming.

Once the Fed turns dovish, it will drive down the benchmark yield and have a negative impact on the U.S. dollar index.

  This also means that the inversion of the interest rate differential between China and the United States is expected to narrow.

At present, the yield of the 10-year U.S. Treasury bond has fallen from the previous 4% to around 3.55%, while the yield of China’s 10-year Treasury bond has risen to around 2.928%. To around 60BP.

  In terms of the prospect of international capital allocation to China's bond market, Xia Minmin, a China interest rate market strategist at UBS Securities, told reporters that last year's sell-off was mainly due to the sharp inversion of the interest rate gap between China and the United States and the weakness of the renminbi. "This year, these unfavorable factors There will be some improvement. UBS currently predicts that the yield on the 10-year U.S. Treasury bond may drop to around 2.65% by the end of this year, and the yield on China’s 10-year Treasury bond is expected to be around 2.9%. Repair. In addition, UBS expects that the dollar/renminbi will be at 6.8 by the end of this year, and the relative strength of the renminbi will help restore the allocation needs of overseas institutions.”

  However, the attractiveness of China's bond market to funds is also closely related to the trend of the market itself.

Since November last year, due to the sudden tightening of liquidity, the bond market has sold off sharply. The yield of 10-year treasury bonds has soared from the 2.6% range to over 2.9% at present, and bond funds have also suffered substantial redemptions.

  At present, the capital level in the first week of January is relatively stable. "DR007 basically fell below 1.5% last week, which is close to the low point of last year. And we saw that the repurchase transaction volume in the market had a significant increase in early January. The rebound, for example, the single-day trading volume of pledged repurchase has exceeded 7 trillion yuan, which may mean that some market participants have increased leverage in an environment of loose liquidity.” Xia Min said.

  She believes that the 700 billion MLF (medium-term lending facility) expires before the Spring Festival, plus the regular tax payment period in the middle of this month, and the early Spring Festival this year, these factors will make the liquidity before the holiday face certain challenges This may lead to a rise in repurchase rates, so institutions expect that the central bank will still take certain actions to maintain financial stability, and maintain an MLF investment of 100 billion to 200 billion yuan this month.

  On the whole, the current momentum of China's economic recovery has led to a relatively volatile outlook for the bond market.

Wang Qiangsong, head of the Wealth Management Research Department of Southern Bank, told Yicai Global that the current round of China's economic cycle began in September 2019 and has lasted for 40 months as of December 2022.

Judging from the impact of the epidemic, the bottom of the economy will appear in December 2022 and January 2023. The economy is coming out of the most difficult moment. The economic "cold wave" period is passing, and the market is still looking forward to more stimulating new policies on the demand side.

As far as bond market investment strategies are concerned, ride-hailing strategies are still more cost-effective, while coupon strategies and leverage strategies are less attractive. Long-term bond trading is currently not recommended.

  He explained that the current bond yield curve is steep, and the term spread is in the high quantile of around 70% to 80%. The central bank’s work in 2023 determines that the liquidity tone is “reasonably sufficient”, and there are no obvious signs of economic and employment improvement. The probability of a flattening curve in the near future is low, and the ride-hailing strategy is the most cost-effective; at present, there is a lot of room for leveraged arbitrage, and the leveraged strategy can still be profitable, but the attractiveness of the strategy is declining.

In the past two weeks, the leveraged strategy can enjoy some capital gains, and the income in this area will decrease in the later period. In addition, the size of the pledged repurchase has risen to a historical high of 7.3 trillion, and the leveraged strategy is already crowded; the attractiveness of the coupon strategy is also declining rapidly. In the past three weeks, 1-3 year credit bonds have fallen by 50BP~60BP. After the rapid compression of credit spreads, and the repair of credit bonds has spread to low-rated and weakly qualified entities, the repair of credit bonds is coming to an end, resulting in the collapse of coupon strategy. Lower cost performance; as far as long-term bond transactions are concerned, because the absolute value of interest rates is low, economic recovery and counter-cyclical policy expectations cannot be falsified, and the bond market has just undergone a three-week recovery, long-term bond transactions are not cost-effective. The central bank has measures to cut interest rates, and the bond market will most likely trade in the form of cashing in profits, so long-term bond trading is currently not recommended.

International funds rush to raise Chinese stock market

  Compared with the cautious and optimistic attitude of international funds towards China's bond market, institutions currently prefer equity assets.

  Since the beginning of this year, northbound funds have flowed back to A-shares substantially, reaching a total of 33.52 billion yuan, and the inflow for the whole year of 2022 will only be about 90 billion yuan.

It is worth mentioning that, compared with A-shares, the offshore Chinese market, which had previously experienced a half-cut, has rebounded strongly. As of last week, the MSCI China Index has rebounded 46% from the previous lowest point. This historic rebound will reduce the decline of the index in 2022 Shrinking to 24%, the upward momentum has extended into 2023, and the index rose 8% in the first trading week of the new year, which is the best start since 1995.

  According to the reporter's understanding, international funds are mainly rushing to raise Hong Kong stocks and Chinese concept stocks recently. Among them, the Internet sector has been more sensitive to the relaxation of regulatory policies and the reduction of the risk of delisting of Chinese concept stocks due to the large decline earlier.

Liu Yaokun, an analyst in the Internet, media, and education industries of UBS Securities China, mentioned to reporters a few days ago that according to feedback from customers and trading desks, the main participating institutions are domestic investors (south capital) and international hedge funds. The assessment period of these investment institutions relatively short.

"Long-term funds are still under-allocated to the Chinese market, including the Internet sector. Therefore, in terms of the positions of overseas institutional investors, there is still room for further restoration."

  Coincidentally, Xu Fei, head of alternative investment and multi-asset strategy at Vanguard Quantitative Equity Group (QEG), also told reporters, “Hedge funds have been aggressive in rushing to raise funds recently, but relatively long-term active mutual funds are still holding a wait-and-see attitude. Because the rebound is very fast now, and the valuation has changed from being very underestimated to a more reasonable one.”

  He also said that international active long-term funds are generally more conservative, with more emphasis on geopolitical considerations, and a more sustainable return will take some time.

Talking about A-shares and Hong Kong stocks, Xu Fei said that although Hong Kong stocks have rebounded more recently, they still prefer A-shares, "Because A-shares have very few Internet components, they own a majority of companies that will benefit from China's consumption rebound and real estate bottoming out. exposure".

  As far as specific sectors are concerned, UBS told reporters that the over-allocated industries this year mainly include-leisure services: hotels, tourism and duty-free industries will benefit from the recovery of tourism demand; household appliances: major appliance companies will benefit from real estate activities Stabilization and reduction in raw material costs.

Due to the sector's current valuation is relatively depressed, the industry's risk-reward ratio is attractive; food and beverage: the release of lagging demand will promote consumption recovery.

The condiment and beer industries will benefit from the revival of offline catering activities.

Demand in the dairy industry may accelerate growth and profit margins are expected to expand; new energy battery industry chain: This industry has strong growth potential.

The order of preference within the sector is Separator/Equipment>Anode/Electrolyte>Anode>Carbon Nanotube; Computers: Government-oriented information service providers will benefit from new infrastructure projects for localization and digitization.

Vertical leaders are benefiting from demand driven by structural trends such as smart vehicles, industrial software, and cybersecurity.