China’s bond market wobbled as the central bank grappled with bond bulls

SHANGHAI/HONG KONG (Reuters) – China’s bond market, the world’s second-biggest, is buoyant after a tumultuous week in which the central bank began to intervene heavily to stem a fall in yields even as the economy struggles .

But die-hard investors say the bull market for government bonds still has legs, citing China’s shaky economy, deflationary pressures and low investor appetite for riskier assets.

“We remain actively bullish,” said one bond fund manager, undeterred by the government’s unprecedented moves to cool the Treasury market and stem a decline in yields, which are moving inversely to prices.

“We don’t see a rosy economic picture … and we are under peer pressure to generate profits,” said the Beijing-based manager, who asked not to be named because of the sensitivity of the subject.

Even those who have become bears seem half-hearted. Treasury futures investor Wang Hongfei said he chose to be “opportunistic” in the short term, trading quickly in fights as the market’s battle with regulators intensifies.

China’s central bank has repeatedly warned of the risks of potentially destabilizing bubbles as investors chase government bonds and away from volatile stocks and a falling property market as banks cut deposit rates. Falling yields also complicate efforts by the People’s Bank of China (PBOC) to stabilize the weakening yuan.

But as the PBOC now turns threats into action to tame bond bulls, the authorities have opened a new battlefront – following long-fought wars of attrition against speculators and unwanted price movements in the country’s stock and currency markets.

Unlike the West, “China’s financial markets, including the bond market, are subject to top-down regulation,” said Ryan Yonk, an economist at the American Institute for Economic Research.

As the economy rumbles, “Chinese officials will face increasing difficulty in keeping such tightly controlled financial markets, and further interventions are likely and may signal the very instability Chinese officials are trying to avoid.”

FIRST LOCATION

The first blow was delivered last Monday, when China’s long-dated yields hit record lows amid a global rout that sent money into safe havens such as Treasuries.

State-owned banks were seen selling large amounts of 10- and 30-year Treasuries after Treasury futures hit record highs.

Debt dumping by state-owned banks – confirmed by data and traders – continued throughout the week, reflecting how the central bank uses big banks as agents at times to influence the yuan’s foreign exchange market, traders said.

The story continues

Late on Friday, the central bank said it would gradually increase the purchase and sale of Treasury bonds in its open market operations.

PBOC Governor Pan Gongsheng was previously head of China’s foreign exchange regulator, so “it seems to be the same playbook,” said a Shanghai-based fund manager.

In another warning to bond buyers, the PBOC on Wednesday stopped providing cash through open market operations for the first time since 2020, contributing to the biggest weekly withdrawal of cash in four months to support yields.

In a further blow to market sentiment, China’s interbank watchdog said it would investigate four rural commercial banks for suspected bond market manipulation and report several misbehaving financial institutions to the PBOC for penalties.

The PBOC did not respond to a Reuters request for comment.

“THE COURSE OF DAMOCLES”

Of course, the wave of measures has made some investors wary. Both China’s 10-year and 30-year Treasury futures posted their first weekly decline in a month.

“Taking all factors into account, it would be prudent to be extra cautious on China’s duration risk,” said Kiyong Seong, chief Asia macro strategist at Societe Generale, referring to the risk of holding long-dated bonds. .

“While the magnitude of any sell-off in Chinese bonds may not be substantial over the medium to long term due to fragile growth momentum in China, tracking long-dated yields in China does not appear appropriate in our view.”

Minsheng Securities analyst Tan Yiming wrote in a note: “The sword of Damocles is falling.”

But in a so-called “asset-starved” environment where high-yielding assets are in short supply, “the bond bull remains alive,” Tan said.

The Shanghai-based fund manager said there was no reason to throw in the towel without seeing clear signs of economic improvement and his strategy was to “buy on the dip”.

“You can’t change the direction of the market using technical tools any more than you can change the temperature by adjusting the thermometer,” he said.

The PBOC’s moves could change the pace of bond price growth, but not the upward trend, he said. “If you stick around long enough, you’ll make money.”

However, rising volatility shows that the central bank is at least making progress in giving investors pause for thought.

Chun Lai Wu, head of Asia Asset Allocation at UBS Global Wealth Management, warned that the expected support for Chinese bonds from any monetary easing is likely to be somewhat offset by accelerated government bond issuance.

China’s 30-year Treasury yield is currently around 2.37%, compared with 3% a year ago.

“Longer term, we could see … the yield drift higher, perhaps towards 2.5%, if indeed we see the economic recovery continuing and inflation starting to come back.”

(1 USD = 7.1715 Chinese Yuan Renminbi)

(Reporting by Li Gu and Samuel Shen in Shanghai; Summer Zhen in Hong Kong; Editing by Kim Coghill)