A Standard Chartered employee counts yuan banknotes at one of the bank’s branches in Hong Kong. The yuan, once Asia’s best carry trade, closed at a four-year low last week and the yield advantage of China’s sovereign debt over US Treasuries fell to the narrowest in five years.

Bloomberg
Taipei

The two best reasons to buy Chinese bonds are fast fading.
The yuan, once Asia’s best carry trade, closed at a four-year low last week and the yield advantage of China’s sovereign debt over US Treasuries fell to the narrowest in five years. Currency appreciation bets and higher yields drew 93bn yuan ($14.4bn) into Chinese bonds from foreign investors in the first half.
Their holdings shrank 2.4% in August, the most since the data started in 2014, as the Federal Reserve prepared to increase interest rates while the People’s Bank of China cut borrowing costs.
“There’s not much to gain from buying Chinese bonds,” said James Yip, a Hong Kong-based fund manager at Shenwan Hongyuan Asset Management (Asia) Ltd, which invests offshore yuan in onshore markets. “Yields are low and currency depreciation is forcing investors to use offshore protection to hedge the risks. The appeal is much, much less than one or two years ago.”
The fading draw of Chinese bonds challenges President Xi Jinping’s push to broaden global use of the yuan, which just last month won entry into the International Monetary Fund’s basket of reserve currencies.
Foreign capital is also needed to offset ongoing domestic outflows, which are threatening to destabilize the exchange rate and push up borrowing costs amid the slowest economic growth in 25 years.
Overseas investors’ Chinese bond holdings rose 14% in the first three quarters to 764.6bn yuan, compared with a 68% increase in 2014.
Foreign ownership will rise 10% next year to 900bn yuan, Gu Ying, an emerging Asia currency and rates strategist at JPMorgan & Chase Co, predicted in a December 9 report.
That would be the weakest expansion since the onshore bond market was opened to overseas funds in 2009.  “The perception around yuan stability and the fact that things have to be more flexible have obviously changed the appeal of Chinese bonds,” said Joel Kim, the Singapore-based head of Asia-Pacific fixed income at BlackRock, which oversees $4.5tn. “Clearly yields have gone down as China has been easing policy.”
The gap between Chinese and US five-year government bond yields has narrowed 70 basis points this year to 116 basis points, less than half the record 319 basis points in 2013. Twenty of 24 economists surveyed by Bloomberg expect the PBoC to lower the benchmark rate further in 2016 after delivering six cuts over the past 13 months.
As for the US, futures are pricing in 64% odds of the Fed funds rate being at least 0.75% by end-2016, compared with the current effective rate of 0.14%.
Global interest is waning just as China widens foreigner access. In July, authorities made it easier for sovereign wealth funds and overseas central banks to trade in its interbank bond market, among a swathe of measures allowing the yuan to enter the IMF’s Special Drawing Rights.
Sustained outflows have made attracting capital all the more urgent. Foreign-exchange reserves fell $87bn to $3.44tn last month, more than double the $33bn drop forecast by economists in a Bloomberg survey, as the central bank sold dollars to prop up the yuan. Bond supply is also increasing due to a rising budget deficit and a three-year, 15tn yuan program to swap local governments’ higher-yielding debt into municipal securities.
Even investors eyeing capital gains from onshore debt may be disappointed. The 10-year government bond yield will rise from 3% on Thursday to 3.2% at end-2016, ending a two-year rally, according to the median estimate in a Bloomberg survey of analysts.
The comparable US yield will rise 55 basis points to 2.78% at the end of next year, a separate survey showed.
Demand for Chinese assets may be given a boost by the increased use of the yuan in international trade, said Shenwan Hongyuan’s Yip.
The currency was the fifth most-used for global payments in October, accounting for 1.92% of the total. It ranked seventh a year ago.