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Chinese bonds could trigger 'tremendous' demand from Wall Street

A rally welcoming China's president Xi Jinping during to Washington last year.
Andrew Birja | AFP | Getty Images
A rally welcoming China's president Xi Jinping during to Washington last year.

Suddenly, Wall Street is getting more serious about investing in Chinese bonds.

The "potential demand is tremendous," Rick Rieder, global chief investment officer of fixed income at BlackRock, told CNBC Tuesday. Major bond indexes are "probably going to include Chinese debt," requiring funds tracking those indexes to buy a corresponding percentage, he said.

The bonds in question are not the privately issued bonds that have given rise to concern among economists about China's overall debt problems. Instead, they're government debt backed by Beijing.

Beijing has long wanted foreign inflows to help stabilize its financial markets. China's overall bond market is the third largest in the world at $9 trillion, but foreign investors own just 1.2 percent of that total, due to government restrictions and the bonds' exclusion from global benchmarks. But Wall Street's attitude toward Chinese bonds may soon change.

On March 1, Bloomberg launched two fixed income indexes that include yuan-denominated Chinese bonds. A couple days later, Citi said it will consider including mainland Chinese bonds in three government bond indexes. The announcements follow loosening restrictions on overseas investment from the Chinese government.

In the latest development, last week Chinese Premier Li Keqiang said in a press conference that China plans to test giving foreigners in Hong Kong access to mainland exchanges.

"The market's getting so big, they almost have to" include the Chinese bonds, said Peter Boockvar, chief market analyst at The Lindsey Group. "It's just a matter of time."

Morgan Stanley analysts said in a March 13 note they expect onshore Chinese bonds to be included in global benchmark indexes within the next three years, sending $250 billion to $300 billion into that market.

According to their analysis, Chinese government bonds could rise to the same level as U.K. gilts or German bunds, accounting for 3 to 5 percent in global indexes.

Deutsche Bank and Citi also put out reports earlier this month discussing the opportunity in Chinese bonds.

Relatively higher yields in the asset class also makes them more attractive for investors.

The Chinese government 10-year bond yield is near 3.31 percent, versus 2.41 percent for the U.S. 10-year Treasury yield. The German 10-year yield is near 0.41 percent, while the Japanese 10-year yield is barely positive, near 0.057 percent.

"Chinese Treasurys certainly offer a premium to say, developed market sovereigns, with a very stable currency," said Brendan Ahern, chief investment officer at KraneShares. The firm sells Chinese exchange-traded funds listed in the U.S., including the KraneShares E Fund China Commercial Paper ETF (KCNY).

"China's currency has actually been less volatile than the euro, yen and pound," he said.

The latest flurry of reports are not the first time major Wall Street firms have highlighted the opportunity in Chinese debt. In September 2015, Goldman Sachs said foreign investment in Chinese bonds could add $1 trillion to that market. The firm did not have a recent report on Chinese fixed income when contacted by CNBC this week.

JPMorgan, which compiles a third global benchmark fixed income index, did not immediately respond to a CNBC request for comment.