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Bond investors go green: Three-minute macro

Green bonds are flying off the shelves thanks to an investor push for more sustainable portfolios. We also shed light on how price earnings ratios have done during past rate tightening cycles and why Chinese credit growth may not be a boon for the global economy.

The Greenium

With the number of ESG mandates and investor interest in green investments on the rise, it’s no surprise that both corporate and sovereign green bonds reached a record number of issuances in 2021. This ballooning demand for green bonds has fueled a “Greenium”— a lower yield (and higher price) on a green bond vs. a vanilla bond with the same maturity. Thanks to the increasing investor interest in sustainability, green bonds have become cheaper for issuers, but more expensive for investors than their non-ESG counterparts.

The Greenium is present in the corporate bond market, but is more easily observed in government bonds. How much are investors paying for the “right” to invest in a green bond? The Greenium on 5-, 10-, and 30-year German green bonds is 11.1, 6.2, and 3.6 basis points, respectively. Demand for green bonds is also evidenced by the substantial oversubscriptions in recent green bond auctions: Italy’s 24-year sale in March 2021 was 10 times oversubscribed, while auctions for U.K. and Danish issuances were both 5 times oversubscribed. While Europe is the leader in the green bond space (a partial funding source for the NextGenEU stimulus), other countries are making strides in their green bond issuance given that it’s a cheaper way to finance growing ESG requirements. In Asia, Indonesia and Hong Kong have issued the most green bonds, and we expect Canada and the United States to follow European sovereign’s lead. We suspect that a continued ESG focus from issuers and asset managers will support the Greenium moving forward. 

Bond investors are going green

German Bund yield curve—green bonds vs. vanilla bonds

Chart of German yield curve, green bonds vs vanilla bonds. It shows that Green bonds have a slight premium to vanilla bonds.
Source: Manulife Investment Management, Macrobond, as of January 25, 2022. 

Price earnings multiples and the rate cycle

Although the U.S. Federal Reserve (Fed) has kept interest rates unchanged as of now, it looks to be setting up a March rate hike, saying it will “soon be appropriate” to raise rates. Meanwhile, quantitative easing is set to end in March. While we believe there will be fewer rate hikes than consensus this year, we have no doubt that monetary policy will be a large determinant of asset returns in 2022.

With the S&P 500 Index’s 12-month forward price-to-earnings (P/E) ratio currently at 19.2x, the only other time when valuations were this high heading into a Fed tightening cycle was in 1999. The bad news (for bulls, anyway) is that P/E multiples typically contract during all periods following the first rate hike in a cycle, with the deepest contraction occurring at the end of the tightening cycle (which we define as the last rate hike before stopping). This makes intuitive sense as the economy approaches the end of a business cycle.

If we take a more granular approach by looking into value versus growth stocks, we learn that value multiples typically contract after the Fed tightening cycles start. Growth multiples typically expand heading into the Fed tightening cycle, with mixed results once the tightening cycle has commenced. All of this has implications for strategic asset allocation as tighter monetary policy could act as a headwind to equities. 

Image showing S&P 500 valuations in Fed tightening cycles. It shows that valuations have decreased during all tightening cycles since the 1908s, and they are more pronounced towards the end of the cycle.
Source: Manulife Investment Management, as of February 8, 2022. 

Chinese debt growth might not fuel the global economy

An expansion in Chinese credit typically heralds a period of growth for the global economy; however, that might not be the case this time. We don’t expect Chinese credit growth to affect broad economic growth globally since, in our view, China’s private credit channel is impaired—an issue that predates COVID-19, and which has become progressively worse in recent years.

The sharp rise in coordinated fiscal and monetary splurge since 2016 has increased the level and growth of Chinese general government debt without leading to an increase in nonfinancial credit growth. In other words, China’s government borrowing has dominated overall credit growth for the past six years. As a result, China’s credit intensity of GDP has risen sharply. Before the global financial crisis (GFC), China needed an average of 1.2 units of credit to generate 1.0 unit of GDP. But the ratio deteriorated to 3.9 units following the GFC, and even more in the pandemic era, to 6.7 units. The end result is that it now takes almost twice as much credit to generate GDP in China as it did a decade ago, and nearly six times as much as before the GFC.

Higher credit intensity over the past years has fueled China’s debt engine—public and private debt continue to hit new highs and the private sector debt service ratio is above 20%, double the pre-GFC level. We’re of the view that Chinese authorities understand that the advantages of injecting more credit into the economy at this stage in the cycle are outweighed by the disadvantages. 

It's taking more and more credit to generate GDP in China

Chinese credit intensity

Line chart showing the credit intensity in China. It shows that it takes almost twice as much credit to generate GDP in China as it did a decade ago, and nearly six times as much as before the GFC.
Source: People's Bank of China, Bank for International Settlements, China National Bureau of Statistics, Macrobond, Manulife Investment Management, as of January 28, 2022. 

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Erica Camilleri, CFA

Erica Camilleri, CFA, 

Senior Global Macro Analyst, Multi-Asset Solutions Team

Manulife Investment Management

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Frances Donald

Frances Donald, 

Former Global Chief Economist and Strategist

Manulife Investment Management

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