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For weeks the People’s Bank of China has voiced concern about a bubble forming in the country’s sovereign bond market. Now it has moved from talking about the problem to arming itself for its first direct market intervention in decades.
On Friday the central bank said it had struck deals with several institutions to borrow several hundred billion renminbi of long-dated bonds that it can sell into the market to try to satisfy demand. The PBoC said it would continue to borrow and sell the bonds on an open-ended and unsecured basis.
The moves are the strongest signal yet of the central bank’s determination to slow the rush of money into sovereign bonds, which has sent yields — which move inversely to prices — to record lows. The central bank fears that eager buyers such as regional banks may be storing up trouble if yields rebound abruptly and the value of their holdings drops, creating the potential for a crisis similar to the collapse of Silicon Valley Bank last year.
Already the signals have had some effect. Yields on 10-year debt, which touched an all-time low of 2.18 per cent last week, climbed above 2.3 per cent on Monday after the PBoC unveiled another tool of market intervention, this time saying it would start temporary bond repurchases or reverse repo operations to try to reduce the volatility of interbank interest rates.
But some analysts doubt that the central bank can push back against this demand for bonds forever, given that demand has been driven by a struggling economy mired in a property downturn in which prices are barely rising and investors see few other attractive places to put their cash amid flagging equity markets.
“The forces pushing down long-term yields are mostly structural and we doubt that they will reverse any time soon,” said Julian Evans-Pritchard, head of China economics at Capital Economics, in a note published on Friday.
The PBoC has warned repeatedly since April against the bond-buying frenzy. In mid-June PBoC governor Pan Gongsheng said yields were too low and other central bank officials also told state media that the ideal range for 10 year-government bond yields was between 2.5 per cent and 3 per cent.
For some analysts, China’s revival of bond market intervention — its last meaningful purchase was in 2007 — is sensible at a time when other instruments to influence the financial system are proving less effective. While China’s economy was growing rapidly, the PBoC was able to exert influence over banks by focusing on controlling the supply of lending. But it has had to rethink its approach as demand for credit has slowed and as banking liquidity has shifted into other assets such as bonds.
The question of whether the PBoC can manage the bond market will become even more important give that China plans to issue trillions of renminbi more in long-dated bonds in the coming years to increase central government leverage and spending. So far the PBoC only holds Rmb1.52tn in government bonds, mostly with shorter maturities.
Chen Long, co-founder of Beijing-based consultancy Plenum, said the PBoC’s approach had some similarities with the yield curve control adopted by the Bank of Japan during the past decade. But whereas the BoJ was trying to set a ceiling for yields, the PBoC is trying to create a floor.
So far though, critical details of any operation, including the timing, size, cost and frequency of the PBoC’s bond trades, are yet to be revealed.
“It’s hard to say how much firepower is needed as the PBoC needs to review the market step by step,” said Richard Xu, chief China financial analyst with Morgan Stanley. “The market is expectation-driven — sometimes a simple verbal warning can change the course, but in other scenarios it needs to take firmer actions.”
The central bank was “unlikely to go all in”, said Gary Ng, a senior economist at Natixis. “It is more of a policy signal unless the intervention is massive, as the goal is to smoothen volatility rather than [change] the market trend.”
Ng estimated that the PBoC would probably need to purchase at least 5 per cent of outstanding government bonds — which would still be less forceful than the BoJ’s interventions — to make a significant difference. China’s government bond market is worth Rmb30tn.
Chen from Plenum also pointed out that a key element of Japan’s yield control was the BoJ promise to buy an unlimited amount of bonds.
“If the PBoC is serious about setting a floor [for yields], it must also promise to sell an unlimited amount of government bonds at that level. It is still unclear if [it] is willing to go that far or what its exit strategy would be.”
Experts caution that pushing up yields will be difficult in China’s current deflationary environment. New loan growth has slowed more than expected this year. Official data on “total social financing”, a broad gauge of credit growth, showed a rare contraction in April, its first decline since 2017, while new data released in June showed a weaker than expected rebound in May.
A further complication is a tug of war between the PBoC and the finance ministry, for which lower yields mean it can issue bonds at a lower cost, said a finance industry researcher at a state think-tank.
The researcher said if the finance ministry had accelerated bond issuance in the first half of 2024 to ease demand pressure, the central bank would not have needed to send so many verbal warnings.
Evans-Pritchard of Capital Economics said in his note that even if the PBoC did succeed in influencing long-term yields, the direct impact on the economy would be marginal given that long-term rates had limited impact on corporate and household borrowing.
“For now, the PBoC has retained a dovish tilt in its policy statements,” he said. “What happens to policy rates and yields at the short end of the curve will remain more important for the economic outlook.”
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