Are China’s woes hitting bonds as well as equities?

The equity slump last month was notable for the relatively muted reaction in certain bond markets.

While 10-year gilt, US Treasury and bund yields all ticked lower initially in August, the moves were minor in comparison with recent history.

Kames Capital head of multi-asset Scott Jamieson said: “The recent turbulence within equity markets has not been met with the degree of bond strength seen in similar periods since the 2008-09 crisis.

“Bond yields are already low, but that didn’t stop German bund yields achieving just 7 basis points [bps] in the teeth of the Greek crisis in April. The possible implosion of the Chinese credit system is every bit as serious a threat, but bund yields are currently a lofty 70bps.”

Mr Jamieson claimed central banks disposing of their reserve assets might be having an impact on fixed income markets.

He noted that while China and various oil states had “hoarded their current account surpluses” during the past 30 years, these assets had begun to shrink as the Chinese economy slowed and oil state revenue collapsed.

“Not only does this represent reduced demand for hard currency bond markets, but also the potential for the forced sale of these bonds,” he said.

“The recent fresh slide in the price of oil may be disinflationary and thus should be good news for bond investors, but the threat of central bank selling looks to be trumping that driver.”

Analysts at Citigroup have estimated that global central banks cut foreign exchange reserves by as much as $260bn (£168.8bn) in the second quarter of 2015, the highest figure in more than a decade, largely in order to defend their currencies from further falls.

John Stopford, co-head of multi-asset at Investec Asset Management, agreed the selling of reserves might have had an impact on bonds.

He said: “Central banks are having to run down reserves. Previously this [holding of reserve assets] was a source of demand supporting prices.

“There is also the fact that the US Federal Reserve is inclined to raise rates and the fundamentals [needed] to change that mood.

“If the market were to price in a recession, you would see a bigger response [in yields] because other factors could overwhelm those negatives.

“For example, reserve asset selling could be offset by other defensive investors,” he added.

However, Rathbones asset allocation strategist Edward Smith is not convinced that selling by the People’s Bank of China and other central banks is driving yields up.

“We can decompose bond yields into three components: expectations for the path of policy interest rates, expectations for inflation, and the term premium,” he said.

“Using the [Federal Reserve Bank of New York’s] model, the term premium has decreased in the past three months, which suggests that Chinese selling has not been the cause of higher bond yields as one might have expected, given the equity market correction.”

But Brewin Dolphin head of fund research Ben Gutteridge said if China was having an impact on the bond market, it could soon manifest itself in a different way.

He said: “China’s growth challenges are having an outsized impact on inflation due to its aggregate demand for commodities. An absence of inflation will keep downward pressure on bond yields. There is no imminent sign of Chinese economic amelioration.”