China bond outperformance tells a bigger story

China’s stock investors could be excused for feeling like President Xi Jinping is disinterested in their plight as market valuation losses mount.

Bond punters seem ascendant, though, as Beijing officialdom makes clear it has their backs in the way few international funds saw coming.

The hyper-targeted nature of policy rescue efforts by the People’s Bank of China (PBOC) and other arms of the state explain why yuan-denominated corporate bonds were among the globe’s best-performing asset classes last year.

The dollar bonds of local government financing vehicles (LGFV) were also big winners in 2023. Unlikely, too, given all the hand-wringing about the US$9 trillion LGFV debt mountain.

The borrowing binge has credit rating companies worried that municipal debt will be China’s next crisis, one that could dwarf today’s huge property troubles.

The reason bonds are winning: Xi’s team understands that a vibrant sovereign bond market is needed to defuse the property crisis and head off a local government debt meltdown. The same goes for achieving Xi’s bigger goal of replacing the dollar as the linchpin of trade and finance.

That’s not to say Xi’s team has given up on putting a floor under China’s stock markets or gross domestic product (GDP). In 2023, inflation-adjusted GDP beat Beijing’s target to grow at 5.2%. But nominal GDP slipped to 4.6% from 4.8% a year earlier as deflationary pressures mount.

To economist Zhang Zhiwei at Pinpoint Asset Management, nominal GDP trailing real output “suggests China is likely growing below its potential growth. More supportive fiscal and monetary policies would help China to restore its growth potential.”

Economist Duncan Wrigley at Pantheon Macroeconomics says news that domestic loan growth