China bond market in turmoil as central bank confronts bond rally

China’s bond market, the world’s second-largest, has become jittery after a turbulent week in which the central bank began intervening heavily to stop yields falling even as the economy struggles.

But hawkish investors say the government bond bull market still has strength, citing China. volatile economyDeflationary pressures and reduced investor appetite for riskier assets.

“We are continuing our aggressive upward trend,” said one bond fund manager, undeterred. Unprecedented government moves To cool the jittery Treasury market and stop the sharp decline in yields, which move inversely with prices.

“We are not seeing a rosy economic picture… and we are under peer pressure to deliver returns,” said the Beijing-based manager, who asked not to be identified because of the sensitivity of the issue.

Even those who have turned bearish seem unenthusiastic. Treasury futures investor Wang Hongfei said he has chosen to be “opportunistic” in the short term, trading quickly on the skirmishes as the market’s battle with regulators intensifies.

China’s central bank has repeatedly warned of the risk of destabilizing bubbles as investors buy government bonds and flee volatile stocks and a slumping property market, while banks slash interest rates on deposits. The falling yields are complicating the People’s Bank of China’s efforts to stabilize the weak yuan.

But with the People’s Bank of China now turning its threats into action to tame rising bond prices, the authorities have opened a new battlefront — following long wars of attrition against speculators and unwanted price movements in the country’s stock and currency markets.

In contrast to the West, “Chinese financial markets, including the bond market, are regulated from the top down,” said Ryan Yunk, an economist at the American Institute for Economic Research.

As the economy falters, “Chinese officials will face increasing difficulty in maintaining such tightly controlled financial markets, and additional interventions are likely, potentially signaling the very instability that Chinese officials seek to avoid.”

The first shot was fired last Monday, when yields on long-term Chinese bonds hit record lows amid a global rout that drove money into safe havens such as Treasuries.

Government banks were seen selling large amounts of 10- and 30-year Treasuries after Treasury futures contracts jumped to record highs.

The dumping of debt by state banks – confirmed by data and traders – continued throughout the week, reflecting how the central bank sometimes uses big banks as proxies to influence the yuan market, traders said.

Late Friday, the central bank said it would gradually increase Buy and sell of treasury securities in open market operations.

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

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

In another blow to market sentiment, China’s banking regulator said it would take tough action against troubled banks. Searching Chinese authorities have announced that they will pursue four rural commercial banks on suspicion of manipulating the bond market, and will report several financial institutions involved in irregularities to the People’s Bank of China for penalties.

The People’s Bank of China did not respond to a Reuters request for comment.

Certainly, China’s series of moves have made some investors cautious. Chinese 10-year and 30-year Treasury bond futures posted their first weekly decline in a month.

“Taking all factors into account, it would be prudent to exercise more caution on the duration risk of Chinese bonds,” said Kyung Seong, chief Asia macro strategist at Societe Generale, referring to the risks of holding long-term bonds.

“While the magnitude of any sell-off in Chinese bonds may not be significant in the medium to long term due to China’s fragile growth momentum, chasing China’s duration yields does not seem appropriate in our view.”

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

But in a so-called “asset famine” environment where high-yielding assets are in short supply, “the bond market is still alive,” Tan said.

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

“You can’t change the direction of the market with technical tools, just as you can’t change the temperature by adjusting the thermometer,” he said.

He said the People’s Bank of China’s moves may change the pace of bond price rises, but will not change the upward trend. “If you hold the bonds long enough, you will make a profit,” he added.

However, the increased volatility shows that the central bank is making at least some progress in giving investors a chance to think.

Chun Lai Wu, head of Asian asset allocation at UBS Global Wealth Management, warned that the expected boost to Chinese bonds from any monetary easing would likely be somewhat offset by increased government bond issuance.

The yield on 30-year Chinese treasury bonds is currently around 2.37%, compared with 3% a year ago.

“Over the longer term, we may see yields rise, perhaps towards 2.5%, if we do see the economic recovery continue and inflation returns.”