China's Fragile Bond Market Slumps Again, 10-Year Treasury Bond Yields Spike to Nearly 4%
Guo Luqing
DATE:  Nov 14 2017
/ SOURCE:  Yicai
China's Fragile Bond Market Slumps Again, 10-Year Treasury Bond Yields Spike to Nearly 4% China's Fragile Bond Market Slumps Again, 10-Year Treasury Bond Yields Spike to Nearly 4%

(Yicai Global) Nov. 14 -- China's bond market has slumped without warning again. Its dominant 10-year Treasury bond contract closed 0.67 percent lower yesterday to hit an all-time low, while the five-year contract dived 0.34 percent.

The yield on the 10-year Treasury bond 170018 swelled by 7.9 basis points to 3.98 percent amid steep rises in interbank bond yields.

"So far, there doesn't seem to be any significant incremental volume," a Beijing-based trader told Yicai Global. "But you can feel that the supply of funds has been quite tight today."

"Transactions were mostly concentrated in 10-year products," a bond investment analyst at a joint-stock bank in Beijing told Yicai Global. "The market has some serious concerns about inflation. Investors previously expected a slowdown in economic growth and by extension a decline in bond yields. Those expectations have fallen, and it may take a long time to restore [investors' confidence in the bond market]."

Investors Are Warned Against a Temporary Liquidity Crunch

"People don't know what caused the market slump, but yields have spiked," a senior fund manager told Yicai Global in an interview.

China's bond market has been undergoing some serious corrections since late September, and stabilized recently until a new wave of changes yesterday.

Market consensus is that liquidity will remain neutral to moderately tight overall considering the government's financial deleveraging efforts, so some portfolio managers foresaw market corrections approaching and a possible liquidity squeeze on the bond market.

"The CNY888.5 billion (USD133.77 billion) net money supply injected last month will likely expire by year-end, and the central bank hopes to return to the 'peak load shifting mode,'" said Zhang Yige, general manager of the fixed-income department at Rongtung Fund Management Co. "[Investors] still need to manage liquidity effectively for their portfolios and stay alert to a temporary liquidity crunch," he warned.
Liquidity has remained tight in the second half, said Wang Shen, research team director at the fixed-income division of Bosera Asset Management Co. The central bank recently resumed reverse repurchase operations, meaning it does not want to go overboard with liquidity tightening.

"Over the medium term, the central bank will return to its neutral to tight monetary policy and open market operations," Zhang said. Both the recent cuts in the required reserve ratio and reverse repos indicate that the central bank wants to keep market rates stable, reduce liquidity fluctuations and channel funds away from the financial markets toward the real economy through long-term funding. As a result, liquidity volatility has eased as of late.

The bank has withdrawn cash from the market and prolonged operations on the open market in line with the government's call for financial deleveraging. Liquidity has remained tight yet balanced.

As of yesterday, the People's Bank of China had withdrawn CNY179.5 billion (USD27.02 billion) from the open market this month. Other than a net injection of CNY107 billion on Nov. 3 through the extension of monthly medium-term lending facilities, and a CNY50-billion injection on Nov. 10, all operations on the open market this month have been net withdrawals or complete offsetting.

The value of new yuan loans was CNY663.2 billion last month, less than the forecast CNY783 billion and almost half the CNY1.27 trillion recorded in September. Social financing in October was CNY1.04 trillion, slightly less than the projected CNY1.1 trillion. The value of social financing in September was adjusted from CNY1.82 trillion to CNY1.8199 trillion.

Broad money (M2) supply rose by 8.8 percent last month, less than the projected 9.2 percent and hitting a new low since 1996, again. Narrow money supply (M1) grew by 13.7 percent, on par with forecasts but down from 14 percent in September. M0 supply climbed 6.3 percent, less than the 7-percent prediction and the 7.2 percent recorded a month earlier.

"Credit growth has been stable overall, despite a stronger-than-expected fall in deposit growth. A cash crunch at banks is the main reason behind the bond market slump yesterday," a CITIC Securities Co. [SHA:600030;HKG:6030] report says. The recent pullback on the bond market is mainly attributable to investors' growing confidence in the resilience of economic fundamentals and widespread optimism about the forthcoming financial data, which prompted them to move ahead of the market curve.

Interest Rates Climb

Interest rates have been rising in economies across the world since Oct. 1, 2016, and China has rolled out its largest ever hikes relative to the US, Germany, Australia, India and South Korea.

"Economic growth slowed only modestly in the fourth quarter, suggesting China's economy still has considerable momentum for growth," the Beijing-based fund manager elaborated. "On the other hand, global interest rates are expected to nudge up across the board after years of quantitative easing.

"It's hard to predict the likelihood of a fall in oil prices, or rather, it's unlikely for oil prices to retreat to a low level," he continued. "Any drop in central prices will be offset by later gains and fluctuations, which is not good on an inflation front."

"As reliance on the real estate sector and fiscal stimuli continues to decrease, the Chinese economy will shift away from its investment-driven model toward intensive growth propelled by technology," Wang Shen said. "It will facilitate lower central interest rates over the long term."

However, from a short- and medium-term perspective, economic fundamentals are still not strong enough to drive 'core growth' in the bond market, he added, saying real opportunities would not arise until deleveraging goals have been fulfilled and debt constraints have been removed from the banking system.

The value of new social financing deals last month stood at CNY1.04 trillion, down almost CNY800 billion from a month earlier, data from the central bank shows. New credit for the real economy decreased on the month to CNY663.5 billion, while trusts, loans by mandate and unfilled acceptances increased by CNY107.4 billion, some CNY285.1 billion less than the previous month.

Rising bond yields have also made bond issuance more difficult for enterprises, and the total value of bond financing last month slipped by CNY5.4 billion on the month to CNY150.8 billion.

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Keywords:   Bond Market,Interest Rates,Macro Economy,Treasury Bonds