In times of global economic uncertainty, bonds, and in particular high yield bonds, offer an attractive return on investment. Investors often view bonds as a safe haven asset, with little risk. This philosophy has typically held true in the past. However, this sentiment might take a turn for the worse in the short term, as the global economic environment has evolved, and deteriorated. If one is not careful, they might find themselves in the midst of a default crisis.   High Yield bonds are predominantly issued by Chinese property developers, as they have a huge demand for cash due to their nature and the size of their projects. Most of their growth is spurred by the growing debt that started around 2015. It made much sense for these corporations back then, as they were growing at a rapid pace, and the economic environment was ripe. However, as economic conditions worsen, and the real estate market becomes more mature and saturated, some Chinese property developers might find themselves unable to expand at a rate that is higher than their interest on their debt borrowings and end up in default.   This situation is magnified by the much talked about trade war between the U.S and China for two primary reasons.   First, and the most obvious reason, is the worsening economic situation in China, as all economic numbers coming from China points to slowing growth. Chinese companies are feeling the impact the trade war has on their operations, and is reflected on their profits. This will likely continue being the case until the trade dispute between the world’s two largest economic nations come to an end.     Second, it is that the trade war has partially evolved into a currency war, where China has devalued its currency against the greenback to relieve tariff pressures. This has led the U.S to label China as a currency manipulator.

The reason why this is relevant to Chinese companies’ ability to repay their debt is that much of their off-shore bonds are denominated in U.S dollar. With their business operations and revenue coming from the Chinese Yuan, they are feeling an increasing pressure to keep up with a depreciating Yuan. With a weakening Yuan, off-shore bond issuers would effectively face higher borrowing costs, and face a higher burden when their bonds mature.

  It should be noted, that in the past, 1 USD to 7 Yuan has been considered to be a critical point, and Chinese officials have sworn to defend this point, to provide stability for their economy. However, as this psychological point has now been breached, there is much more room for the Chinese Yuan to further depreciate against the U.S dollar.   With all that being said, investors should still invest in high yield bonds issued by Chinese property developers, as they offer quite an attractive return. However, this is not the time to put on a cape and be a hero. One should take a more conservative approach, and carefully pick and choose which company’s bonds to invest in. A company’s ability to give out coupon or repay back the principal is much predicated on their company’s financial strength. Those with favorable cash flows, low debt-to-cash ratio, or those with strong ties to the Chinese government should be favored in times like these.