Constructive Despite Deferment

Desmond Soon, Portfolio Manager
30 September, 2019
Constructive on China Bonds despite deferred FTSE WGBI inclusion 

Bond index provider FTSE Russell’s latest decision to have China Bonds remain on its watch list instead of including it in its flagship World Government Bond Index (WGBI) was primarily driven by concerns cited by. primary users on off the run bond liquidity, third party foreign exchange execution and hedging and a longer settlement cycle. FTSE will give a further update post its interim review in March 2020.

In light of FTSE Russell’s decision (which contrast with China bond inclusion by other major bond index providers1), FTSE WGBI will not benefit from the inclusion of higher yielding China government bonds to boost the average index yield above its current 0.83%2. However, if principal WGBI users are accustomed to low yielding bonds, they may not be compelled to make the change.

Flows wise, FTSE Russell’s decision could have a short-term impact on China government bonds, missing out on a potential US$130 billion of passive inflows (WGBI full inclusion ~6%) estimated by Bloomberg3.

Despite this temporary setback, Western Asset’s outlook remains that Asia local currency bonds in selected markets such as China has the potential to outperform broader Emerging Markets in the next 12 months. Asia currencies and local bond yields will benefit from the Fed dovish pivot and low global inflation providing Asia central banks headroom for accommodative policy amid currency stability. Asian local currency bonds continue to offer good value versus developed markets, with the yield spread between the JPMorgan Government Bond Index (Emerging Markets Asia) vs. the FTSE World Government Bond Index at over 230 bps as at the end of August. 

Chart:There continues to be a large yield gap between China and Developed World 10-year bonds (%)

Source: Bloomberg. Weekly data as at 27 September 2019.

Source: Legg Mason, 30 September 2019.
1 Bloomberg Barclays and JP Morgan announced this year a phased inclusion of Chinese bonds into their major bond indices.
2 Bloomberg, as at 27 September 2019.
3 Bloomberg, China Misses Out on Entering FTSE Russell Global Bond Index, as at 27 September 2019

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