China’s Treasury Market Rattled as Central Bank Challenges Bulls – Reuters

SHANGHAI/HONG KONG (Reuters) – Chinese government bonds experienced a steep decline on Monday after a week characterized by significant interventions from the central bank aimed at curbing a sharp drop in long-dated yields amidst an economic downturn.

China’s 10-year treasury futures fell by 0.6%, marking their worst performance in 17 months, while bond yields, which have an inverse relationship with prices, rose by approximately 4 basis points.

Despite this, some committed investors assert that the bullish trend in government bonds remains intact, pointing to the country’s unstable economy, deflationary pressures, and a general reluctance among investors to engage with riskier assets.

"We remain actively bullish," stated a bond fund manager who remains optimistic despite unprecedented government measures intended to suppress treasury market volatility and stabilize yields.

"We don’t see a positive economic outlook… and there’s pressure on us to generate returns," added the Beijing-based manager, who opted for anonymity due to the sensitive nature of the discussion.

Even among those who have adopted a bearish stance, there appears to be a sense of hesitation.

Treasury futures investor Wang Hongfei indicated that he has opted for an "opportunistic" short-term approach, engaging in quick trades as the market grapples with regulatory pressures.

China’s central bank has repeatedly cautioned about potential risks of destabilizing bubbles as investors flock to government bonds while avoiding volatile stock markets and a declining property sector, compounded by reductions in bank deposit rates. Falling yields further complicate the People’s Bank of China’s efforts to stabilize the weakening national currency.

With the central bank now translating warnings into decisive actions to rein in bond market enthusiasts, authorities have initiated a new front of intervention, following protracted campaigns against speculators and unwanted price fluctuations in the stock and currency markets.

In contrast to Western markets, "China’s financial markets, including the bond market, are subject to top-down regulation," noted Ryan Yonk, an economist at the American Institute for Economic Research. As the economy struggles, "Chinese officials are likely to encounter increasing challenges in maintaining such tightly controlled financial markets, leading to further interventions which may inadvertently create the instability that officials are striving to prevent."

FIRST SHOT

The initial move occurred the previous Monday, when China’s long-term yields reached historic lows amidst a global trend driving investment towards safe havens like treasuries.

State banks were observed selling large quantities of 10-year and 30-year treasuries following a surge in treasury futures to record highs. This selling trend by state banks, confirmed by various sources including traders, persisted throughout the week, similar to how the central bank has utilized major banks to influence the currency market in the past.

Toward the end of last week, the central bank announced it would gradually increase its purchasing and selling of treasury bonds in its open market activities. PBOC Governor Pan Gongsheng, a former head of China’s foreign currency regulator, is perceived to be applying a familiar strategy.

In a further warning to bond investors, the central bank halted cash provision through open market operations for the first time since 2020 on Wednesday, resulting in the largest weekly cash withdrawal in four months to support yields.

Additional pressures on market sentiment emerged as China’s interbank regulator announced investigations into four rural commercial banks for potential bond market manipulation, with plans to report several problematic institutions to the PBOC for penalties.

‘SWORD OF DAMOCLES’

The flurry of measures has led to increased caution among some investors. Both 10-year and 30-year treasury futures in China extended their declines on Monday, following their first weekly drop in a month. Other tenors also saw significant selling pressure, with two-year and three-year treasury yields surging by over 7 basis points.

"Considering all factors, it would be wise to exercise further caution regarding the risk associated with long-dated Chinese bonds," advised Kiyong Seong, lead macro strategist at a financial institution, noting that the appeal of duration returns in the current climate may not be justified.

Tan Yiming, an analyst at Minsheng Securities, commented, "The sword of Damocles is descending." However, in a context of limited high-yield assets, he believes "the bond bull market remains intact."

A Shanghai-based fund manager echoed this sentiment, insisting there is no reason to abandon the market without clear signs of economic improvement, advocating a strategy of "buying on the dip."

"You cannot change market direction using technical tools, just as you cannot change temperature by adjusting a thermometer," he explained. He believes that although central bank actions may alter the pace of bond price increases, they do not change the overall upward trend, asserting, "If you hold long enough, you will profit."

Nevertheless, rising volatility within the market indicates that the central bank may be making some strides in prompting investors to reconsider their strategies.

Chun Lai Wu, head of Asia Asset Allocation at a global wealth management firm, warned that anticipated support for Chinese bonds from monetary easing could be somewhat countered by increased government bond issuance.

Currently, China’s 30-year treasury yield hovers around 2.37%, down from approximately 3% a year ago. Long-term forecasts suggest potential upward drift in yields, possibly approaching 2.5%, if economic recovery and rising inflation materialize.