Global investors can relax: China isn't planning to shoot its bond market in the head.
Coming close on the heels of the twice-a-decade Communist Party congress, Monday's 8.5 basis-point surge in the 10-year sovereign yield was all about pent-up nervousness looking for an outlet. After Xi Jinping using his marathon keynote speech to say houses are for living in, not for speculation, and People’s Bank of China Governor Zhou Xiaochuan discussed a "Minsky Moment"-type of endgame for unsustainable credit buildups on the sidelines of the conclave, investors wanted to test the authorities' zeal for genuine deleveraging.
On Tuesday, the PBOC applied the balm of liquidity to tingling nerve ends. Its fund injection was enough to cause the biggest single-day decline in overnight interbank rates since February. Yet yields on the 10-year bond barely slipped 2 basis points from a three-year high. Considering that the manufacturing purchasing managers' index came in slightly weaker than expected, the decline in long-term interest costs was too small to signal an end of fear.
Chinese equities, taking a cue from the fixed-income market, fell for a second day. Dandong Port Group Co. failed to repay some notes on Monday, bringing the total of onshore defaults this year to 20, compared with 21 last year.
All this raises the question: Has the Chinese bond market taken over from U.S. Treasuries as the world's preferred fear gauge?
The answer is no. China won't be able to drive the interest-rate differential with the U.S. much higher. Offshore dollar bond issues by Chinese companies and financial institutions are on track to reach $200 billion this year, double the 2016 amount, according to Natixis, which estimates it's cheaper for mainland firms to sell bonds overseas if they don't need to swap the proceeds back into local currency. Even after factoring in expectations of yuan depreciation, the offshore route is barely more expensive for borrowers.
Without any government guarantees on repayment of principal, buyers are queuing up for the 5.2 percent yield on the 2019 dollar note of Jiangsu NewHeadline Development Group Co., a junk-rated borrower that provides construction services to the municipal government of Lianyungang in the eastern province of Jiangsu.
There's little point in the authorities' clamping down too hard on raising money at home -- companies and local-government financing vehicles will simply go overseas to refinance their debt load. To skirt restrictions on who can go, they'll sell 364-day bills. The end result of the tighter financial conditions will be slower economic growth on the mainland, but very little deleveraging.
Even as it approaches 320 percent of GDP by 2021, according to Bloomberg Intelligence estimates, China's gigantic debt edifice is funded with domestic savings. To swap that comfort for a foreign-currency debt debacle would be suicidal. Investors can take it easy: Beijing may fiddle with liquidity conditions, but it won't risk engineering a bond collapse.
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