- Chinese regulators are tightening control over the country’s government bond market, directing banks in Jiangxi province to retract recent bond purchases.
- The yield on China’s benchmark 10-year government bond, which hit a low of 2.12%, has recovered slightly to around 2.25% following intervention.
- Concerns are rising that these measures, while calming short-term volatility, may erode long-term investor trust and market transparency.
- Foreign investors withdrew record sums from China’s markets in Q2, reflecting skepticism about government interventions.
- Major state banks have been instructed to report information on bond purchasers, signaling an effort to deter speculation.
China is increasingly intervening in its government bond market to manage yields and prevent financial instability, prompting regulators to issue directives that influence rural banks’ bond transactions. This move follows a series of measures aimed at calming excessive volatility after bond yields fell to historic lows amid economic concerns. While these actions have stabilized yields, they pose the risk of diminishing market transparency and deterring global investors. Despite the recent uptick in bond yields to 2.25%, the interventions have highlighted the balancing act Beijing faces in fostering economic growth while ensuring market stability.
Bond Market
Chinese officials are taking exceptional measures to strengthen their control over the world’s third-largest government bond market.
In a very unusual action on Friday, regulators instructed rural banks in China’s Jiangxi province to refrain from settling recent government bond purchases, effectively commanding them to backtrack on their market commitments. It was the most recent in a series of measures aimed at calming a market surge that pushed yields to unprecedented lows and heightened official worries that banks have become overly vulnerable to interest-rate fluctuations.
Currently, the interventions seem to be producing the intended outcome: after reaching a record low of approximately 2.12% earlier this month due to increasing indications of an economic downturn in China, the benchmark 10-year yield has gradually risen to about 2.25%.
However, the danger is that intervention by authorities separates the market from its economic foundations and diminishes long-term investor trust. The government’s efforts to interfere in stock and currency trading in recent years — often with tumultuous results — have discouraged global investors.
In a clear indication of the ongoing pessimism regarding the nation’s assets, data from last week revealed that foreign investors withdrew a historic sum of money from China during the second quarter.
“Those actions have demonstrated their effectiveness in curbing excessive speculation,” stated Serena Zhou, senior economist for China at Mizuho Securities Asia Ltd. “Nonetheless, it is crucial for the government to implement more decisive actions, both monetary and fiscal, to stop deflation expectations.”
Strategy
“All of this diminishes market transparency, which global fixed-income investors value, and may hinder them from allocating funds to Chinese bonds when numerous alternatives exist globally.” The debt surge might be finished for the time being, but the repercussions could take months to resolve.
The saga highlights the predicament faced by Beijing: it must back the sluggish economy by maintaining low borrowing costs, while simultaneously ensuring that money isn’t so inexpensive that a bond bubble develops, threatening financial stability. Officials are aware of the fall of Silicon Valley Bank, which heavily invested in US Treasuries prior to the rate increase, and have been trying to mitigate risks at financial entities.
According to sources familiar with the situation, at least four Chinese brokerages initiated new actions to reduce trading in government bonds starting last week, with one noting that the shift was in response to directives from the authorities. Regulators have additionally requested that some of the biggest state banks in the country document information about purchasers of the sovereign bonds they sold, subtly signaling a clampdown on speculators.
Although state banks have recently been active in the market selling bonds of various maturities, investors continue to await actions from the People’s Bank of China to similarly engage, utilizing the “hundreds of billions” in government debt it claims to have available through arrangements with lenders.
“The PBOC’s worries regarding financial risks are justified.” Xiangrong Yu, an economist at Citigroup Inc., noted in a memo on Monday that it is unsure whether its actions are enough to raise the long-end yield. “Direct intervention would only be a short-term solution, yet bond yields are ultimately determined by economic fundamentals.”
This year, China’s government bonds have experienced a significant rise due to the bleak economic forecast and anticipated interest-rate reductions. The absence of appealing options like real estate and stocks, along with a shift from savings to financial investments, has heightened demand. Even a rise in government borrowing aimed at enhancing fiscal stimulus did not deter buyers.
According to Pictet Asset Management, onshore bonds from China must be included in the diversified portfolios of global investors due to their low correlation with other markets and the strong economic fundamentals of the country. It remains unaffected by possible actions from the PBOC, observing that bond purchases and sales are standard tactics in a central bank’s strategy.
“The absence of low-volatility investment options should make Chinese government bond investments appealing to numerous investors, particularly as the stock market remains challenged and the economy recovers sluggishly,” Pictet’s Cary Yeung and Sabrina Jacobs wrote in a note on Monday. “We believe this is not a reason for worry.”
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