After three months of heavy selling, coinciding with a period of US dollar strength, foreign investors returned to emerging markets across Asia last month, buying both stocks and bonds.
However, after months of solid inflows, they started selling Chinese bonds, continuing the pattern seen in stocks one month earlier.
According to ANZ, foreign capital inflows into the region totaled $US6.1 billion in January, a partial reversal of the massive $US33 billion that flowed out in the preceding three months.
$US3.7 billion went into stocks with the remaining $US2.4 billion allocated to bonds.
And, as this excellent chart from ANZ shows, that may have been driven by renewed US dollar weakness. When it weakens, inflows tend to occur, and when it strengthens, the opposite is generally seen.
Khoon Goh, head of Asia research at ANZ, called the inflows in January “rather modest”, noting that investors were selective in the markets they returned to.
“Equity inflows were concentrated in Korea and Taiwan, and not much elsewhere. Indonesian bonds remain a firm favourite, and the Korean bond market has finally seen decent foreign buying after five straight months of outflow,” he said.
“India and Malaysia, however, continue to see foreign selling. Add to that China now, which saw foreign outflows from the bond market for the first time in close to a year.”
On China, $US3.8 billion worth of bonds were sold, marking the first outflow since February 2016.
Goh says that may have been a sign that demand for Chinese bonds ahead of the yuan’s inclusion in the IMF’s special drawing rights (SDR) basket in October last year may have come to an end.
“This could be an indication that foreign reserve managers, who we suspect had been the main buyers China bonds for most of last year, have reached their targeted allocation of RMB [Chinese yuan],” he says.
“If this is indeed the case, then foreign demand for onshore China bonds will be more subdued.”
Over January, the yield on Chinese 10-year government debt rose by 30 basis points to 3.36%, according to data from Thomson Reuters, the largest monthly increase since August 2013.
The outflows from bonds in January also came despite renewed strength in the Chinese yuan against the US dollar.
It also followed $US4 billion in outflows from Chinese stocks in December which was the largest amount since November 2015.
Looking ahead, Goh says that whether the return of portfolio inflows to the broader region can be sustained is uncertain, suggesting there is no shortage of potential event risks that can trigger fresh portfolio outflows.
“It is still possible that the Fed could surprise by tightening more than what the market is pricing in, Europe is heavy with political risk which the market may be underestimating at present and China risks are never far away despite stabilisation in economic growth, and, of course, we have Trump risk to contend with,” he says.
“What is clear is that given the greater than usual uncertainty facing the external environment, portfolio flows into the region is set to be more volatile.”
Sounds like a year to be a trader, at least for those willing to take on the risk.
Here’s the capital flows for stocks and bonds by individual nation over the past six months. It comes courtesy of ANZ.