Chinese government bonds are likely to attract stronger fund inflows as the central bank pushes interest rates lower just as policymakers in the US and elsewhere prepare to dial back their monetary stimulus, investment bankers said.

The People's Bank of China this week trimmed its key lending rate for the second time in a month as the economy lost momentum in the final quarter of 2021, fanning a rally in sovereign debt and stocks at home. That move has entrenched expectations for more easing, while the Federal Reserve signalled an opposite tightening path.

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Federal Reserve Chairman Jerome Powell and his FOMC members are plotting to dial back bond purchases, stoking a sell-off in Treasuries. Photo Reuters alt=Federal Reserve Chairman Jerome Powell and his FOMC members are plotting to dial back bond purchases, stoking a sell-off in Treasuries. Photo Reuters>

Chinese government bonds have returned 3 per cent in the past six months, while US Treasuries lost 3.2 per cent as policy expectations diverged, according to ICE BofA Indexes. Euro-area government bonds fell 2.8 per cent.

Ten-year Treasury yields rose to as high as 1.9 per cent this month, a level not seen since December 2019, according to Bloomberg data, after minutes from a previous meeting suggested the Federal Reserve is plotting a faster than expected withdrawal of stimulus, with three rate increases in 2022. Chinese government bonds yielded 2.73 per cent recently.

"Compared with overseas bonds, which not only have relatively lower [yields] but also face the risk of falling prices driven by rising interest rates, the returns of Chinese government bonds will remain attractive," said Zhang Xing, Hong Kong head of fixed income, investment banking department, at China International Capital Corp.

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"Foreign investors will continue to allocate capital into Chinese government bonds," said George Sun, head of global markets for Greater China at BNP Paribas. "They not only offer higher [relative] yields. They are also uncorrelated with yields in other developed markets."

A customer shops for vegetables at a supermarket in Nanjing in China's eastern Jiangsu province on January 12, 2022. Photo: AFP alt=A customer shops for vegetables at a supermarket in Nanjing in China's eastern Jiangsu province on January 12, 2022. Photo: AFP>

A weaker yuan could temper appetite for Chinese bonds, as Societe Generale forecast the local currency to depreciate in 2022 to 6.5 per dollar. It strengthened 2.8 per cent in 2021 to a three-year high of 6.3492.

However, investors are also getting better real yields in yuan-denominated sovereign bonds. US inflation surged at the fastest annual pace in nearly four decades in December, increasing 7 per cent from a year ago. China's consumer prices rose by 1.5 per cent last month from a year ago.

This article originally appeared in the South China Morning Post (SCMP), the most authoritative voice reporting on China and Asia for more than a century. For more SCMP stories, please explore the SCMP app or visit the SCMP's Facebook and Twitter pages. Copyright © 2022 South China Morning Post Publishers Ltd. All rights reserved.

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