Markets

Christopher Langner is a markets columnist for Bloomberg Gadfly. He previously covered corporate finance for Bloomberg News, and has written for Reuters/IFR, Forbes, the Wall Street Journal and Mergermarket.

What happens when there are $1 trillion-worth of securities in a market but trading volume is negligible? Nothing... until people decide they want to sell.

That's the situation in China, where the fixed-income market has grown to be the world's second largest yet where bonds hardly ever change hands. Now that a potential default by a state-owned entity has jolted the market out of its complacency, investors are trying to unwind positions. They're finding there aren't enough buyers.

The result has been sinking bond prices and an increase to a one-year high in the cost of borrowing via the 8 trillion yuan ($1.2 trillion) market for repurchase agreements. Corporate debt issuance has dropped to the lowest since January 2014, excluding the week of the Chinese New Year holiday.

Free Falling
Fears of state-backed company defaults have brought corporate bond issuance to a halt in China
Source: Bloomberg
* Data excludes the Lunar New Year week when onshore markets were mostly closed.

The average yield on corporate notes rated AAA by domestic agencies has risen 43 basis points this month, the steepest increase since March 2015: 

Up We Go
Corporate bond yields in China spiked after news of a potential state-backed company default
Source: Bloomberg; ChinaBond

That wasn't what the country needed, when Chinese companies are on the hook for a record 547 billion yuan of onshore bonds maturing in May.

Now, take a step back: This is China. Every time market forces fail and threaten the man in the street, Beijing steps in to fix the problem. When regulators can't come up with a solution, they're happy to reach out to peers across the globe. 

The trouble is that officials in other parts of the world have been grappling with liquidity issues in their own bond markets and probably don't have much advice to offer. U.S. Treasuries, the most liquid market in the world, saw the highest number of uncompleted transactions since 2008 last month, a sign there aren't enough participants to keep trading functioning properly.

That leaves China with few options. The most obvious solution, consistent with the nation's previous actions, would be simply to step in and start backstopping the market. The People's Bank of China could easily provide the liquidity if there weren't enough bond investors willing to buy. 

The pitfall is that this would amount to monetary stimulus. The European Central Bank, for one, plans to start buying corporate debt as a way to try to generate inflation in the single-currency area. China's central bank surely wouldn't mind giving economic growth another push. The question is whether it would be doing this for policy reasons or simply to bail out investors. If the latter, that could undermine the role of market discipline and encourage a further buildup of debt.

As painful as it may be, China would do better to just to let the chips fall as they may. Even in a bond market with relatively few trades, buyers appear when securities get cheap enough. Then default risk starts to be more properly priced, something that hasn't happened yet. Once prices are real, secondary trading can flourish. Don't bet on that happening just yet.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Christopher Langner in Singapore at clangner@bloomberg.net

To contact the editor responsible for this story:
Matthew Brooker at mbrooker1@bloomberg.net