China Tightening Risk Seen Looming as Bonds, Property Surge

  • Home prices getting ‘more crazy,’ Templeton venture says
  • Ten-year sovereign debt yields have fallen to decade-lows

Frothiness in parts of China’s financial markets is pushing the central bank closer to tightening monetary policy.

That’s according to Lirong Xu, chief investment officer of Franklin Templeton’s joint venture in Shanghai, who says debt yields are falling too quickly and home prices are getting "more and more crazy."

While economists aren’t predicting the central bank will raise benchmark lending rates anytime soon, there are signs that policy makers are looking to curb leverage in the debt and property markets. Ten-year sovereign yields are near decade-lows and house prices are surging by double digits in major cities. Since the current easing cycle began in late 2014, the economy has struggled to stage a recovery, suggesting that looser funding conditions by the People’s Bank of China have fueled speculative activity rather than corporate investment. 

"The market’s liquidity right now is too big,” said Xu at Franklin Templeton Sealand Fund Management Co., which oversees about 30 billion yuan ($4.6 billion). “Once the PBOC may think the liquidity level is too high, policy may shift to tightening.” 

Xu, who accurately predicted in February that China’s stocks would rebound, now sees the rally petering out. The Shanghai Composite Index slumped as much as 1.4 percent on Thursday, its biggest loss in three weeks.

China’s top leaders last month pledged to curb asset bubbles in a Politburo meeting led by President Xi Jinping, underscoring their determination to curb risks emanating from a borrowing binge that boosted debt to 2.5 times gross domestic product.

The benchmark 10-year sovereign yield fell to a decade-low of 2.64 percent on Aug. 15, and is down 38 basis points from 2016’s June high. The yield will touch 2.5 percent before the end of this year, according to the median estimate in a Bloomberg survey. New home prices in Shanghai and Beijing jumped at least 21 percent in July from a year ago, with Shenzhen topping the list with a 41 percent increase, government data shows.

The PBOC sold 14-day reverse-repurchase agreements this week, its first offering of anything with a tenor other than seven days since February, spurring speculation officials want to curb leverage in the bond market by making it less profitable for investors borrowing to buy 10-year debt. The government on Wednesday also imposed limits on lending by peer-to-peer platforms to individuals and companies in an effort to curb risks in the loosely regulated shadow-banking sector.

Property Curbs

Shanghai, where prices of new homes jumped 27 percent in July, is preparing to discuss a fresh round of curbs including potential restrictions on mortgages and loans to developers, according to people familiar with the matter. Beijing and Tianjin are also contemplating new measures to rein in prices, according to three of the people.

“High property prices and low real interest rates are constraints that the central bank must work with,” said Hao Hong, chief China strategist at Bocom International Holdings Co. in Hong Kong, who forecast the stock market will consolidate amid fading optimism about additional monetary stimulus. “Liquidity will not be more loose in the second half.”

The central bank will keep its benchmark one-year lending rate at 4.35 percent for the rest of this year, according to 13 of 26 economists surveyed by Bloomberg. The rate was last lowered in October. The reserve requirement ratio for major banks has been held at 17 percent since February.

Neutral Position

The Shanghai Composite, which has rebounded 16 percent from its January low, will lose momentum after repeatedly failing to stay above the 3,000 level this year, Xu said. The index added 0.1 percent at the close.

Retail investors remain bruised by last year’s $5 trillion rout, while the start of an exchange trading link between Shenzhen and Hong Kong will not be an immediate game changer, Xu said, adding that his fund has turned neutral on Chinese shares after being bullish earlier in the year.

"Leverage is rising not in the stock market but in the housing market,” Xu said. "It seems quite dangerous.”

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