China recently raised an impressive US$2 billion through the sale of three- and five-year notes. These securities were priced to offer extremely low yields, with just 1 and 3 basis points (bps) respectively over similar-maturity Treasuries. Once trading commenced on Thursday, spreads tightened to around 24 and 25 bps under Treasuries, as reported by traders. This indicates a strong demand that was evident throughout the debt-sale process, especially during a time when credit markets were highly active.

Signs of Strong Demand and Investor Appetite

Traders attribute part of this strength to the demand from Chinese investors. As local interest rates have been declining, these investors have been seeking higher returns globally. In fact, bids for the US$2 billion deal reached approximately US$40 billion, which is an astonishing 20 times the amount offered. This shows the significant interest and appetite among Chinese investors for such debt instruments.Chinese investors can enjoy tax exemptions on the nation's sovereign debt, which further fuels their enthusiasm. Their eagerness has already led to some of China's previously issued dollar bonds trading at lower yields than Treasuries for a major part of the past year. This is a rare occurrence as U.S. securities have traditionally been regarded as the safest investment option.

Emerging-Market Dollar Bonds: An Attractive Option

More broadly, emerging-market dollar bonds have become increasingly appealing. After the concerns over default risks among sovereign borrowers due to the pandemic eased, the extra yield that investors demand to hold such debt compared to Treasuries has dropped to a four-year low this week. It narrowed to 323 bps, as per a JPMorgan Chase & Co. index.China stands out even in this context. The yield on its dollar note due in November 2027 has been below that of Treasuries for the majority of the past year. According to Bloomberg-compiled data, it was last about 18 bps under the equivalent U.S. government bond. This is quite surprising given that China has lower credit ratings from major international assessors compared to the U.S. For instance, Moody's Ratings gives it an A1 rating, which is its fifth-highest investment-grade score, while the U.S. has an Aaa rating.

Impact of Ratings and Financing Conditions

Although the U.S. still has a higher credit rating, it has faced setbacks in recent years. Fitch Ratings downgraded its score last year to AA+, from AAA, criticizing the country's growing fiscal deficits and the "erosion of governance" that has led to repeated debt-limit clashes over the past two decades. S&P also downgraded the United States to AA+ in 2011 for similar reasons.However, "lack of dollar-bond supply, plus accommodative financing conditions onshore, have led to a strong bid for dollar bonds from China onshore investors," as stated by Xue Zhou, senior China economist at Mizuho Securities Asia Ltd.

Unusual Venue and Geopolitical Ties

While China's newly issued bonds were accessible to global investors, officials last week announced that they would be sold in Saudi Arabia. This is an unusual venue as London, New York, and Hong Kong are typically the preferred locations for such transactions. But this choice comes after recent efforts to enhance economic ties between the two countries. Officials from China and Saudi Arabia met earlier this year to discuss cooperation, and this can be seen in initiatives like the doubling of investment in Saudi Arabia by China's largest steel producer."It is in line with the two countries' rising connections," said Ting Meng, senior Asia credit strategist at Australia & New Zealand Banking Group. "The bond is in the same format as prior ones, but there could be more Middle East investors."The bonds are listed on Nasdaq Dubai and the Hong Kong exchange, providing additional accessibility and liquidity.In September, China sold 2 billion euros (US$2.1 billion) of notes in Paris, marking its first euro-denominated bond sale in three years. Last week, the Ministry of Finance announced a US$1.4 trillion bailout program for debt-straddled local governments, although it refrained from implementing more stimulus measures to boost domestic demand.Bank of China, Bank of Communications, Agricultural Bank of China, BofA Securities, China Construction Bank, China International Capital Corporation, Citigroup, Crédit Agricole CIB, Deutsche Bank, First Abu Dhabi Bank, Goldman Sachs (Asia) L.L.C., HSBC, ICBC, J.P. Morgan, Mizuho, and Standard Chartered Bank played a crucial role in arranging the sale.