It's Turning Into a Really Bad Week for China’s Markets

  • Shanghai Composite poised for worst week since April
  • Yuan weakens to lowest since June 2008 as dollar rallies

It’s turning out to be a really bad week for Chinese financial markets.

The benchmark stock index has tumbled 3.6 percent, poised for its worst week since April. The yuan depreciated to its lowest level against the dollar since June 2008, while government bonds plunged, with the 10-year yield surging by a record 22 basis points on Thursday.

While some of the losses can be attributed to the Federal Reserve’s prediction of three interest-rate hikes next year, China has its own sources of stress. Surging money-market rates sparked by government deleveraging efforts are curbing demand for everything from equities to debt at the same time as capital outflows accelerate. The selloff will probably deepen over the next month, CCB International Securities Ltd. says.

"There are a few problems occurring together," said James Yip, a Hong Kong-based money manager at Shenwan Hongyuan Asset Management (Asia) Ltd. "The People’s Bank of China is tightening marginally, the market’s leverage has been very severe, inflation data is pointing to a reflationary story, the U.S. is raising rates and the currency is depreciating. Everything put together has driven sentiment to this stage."

The Shanghai Composite Index retreated 0.7 percent to a six-week low at the close, while a gauge of mainland equities traded in Hong Kong slumped 2.3 percent in Asia’s biggest loss. The yuan weakened 0.4 percent and the 10-year sovereign yield climbed to 3.45 percent.

Forced Correction

Policy makers have shifted their focus in the second half to reducing financial risks as economic growth stabilized, with PBOC Deputy Governor Yi Gang saying in early September the nation’s short-term goal is to lower leverage ratio growth. By steering money-market rates higher, the PBOC has forced a correction in the highly leveraged bond market, while home prices are showing signs of cooling amid property curbs. Equities also fell this week because of a regulatory crackdown to insurers’ stock investments.

Concern about a faster pace of U.S. rate hikes is exacerbating the losses. Fed officials moved their 2017 rate path projections to three increases from two after the monetary authority raised its benchmark rate by a quarter percentage point on Wednesday.

"Investors are adjusting their expectation on the pace of the U.S. rate hike and they are very cautious," said Peter So, Hong Kong-based co-head of research at CCB International Securities. "There will be an inevitable selloff in bonds, stocks and the yuan in China in the upcoming month, as investors adjust their portfolio based on the new rate expectation and interbank liquidity remains tight at year-end."

Staying Elevated

Still, So said he remains positive on Chinese equities and views the slump as a buying opportunity.

Bond yields are likely to remain elevated for the foreseeable future, according to Andy Ji, a Singapore-based currency strategist at Commonwealth Bank of Australia.

Speculation price gains will accelerate is reducing demand for debt and adding to expectations the PBOC will tighten monetary conditions. The producer-price index jumped 3.3 percent in November from a year earlier, exceeding all 47 estimates in a Bloomberg survey, while consumer prices rose on higher food costs.

"Bond yields are running ahead in the market rout due to the Fed hike expectation, but the recent lift comes more from domestic inflation and the oil price outlook," Ji said. "It’s hard to see yields come off significantly even in the mid term."

The losses are a reminder of the turmoil that dogged China’s financial markets at the start of the year, which gave way to relative calm throughout much of 2016 even as the yuan tracked lower. Citic Securities Co., the nation’s largest brokerage, said last week it was more worried about the money market now than during the 2013 cash crunch, given accelerating fund outflows.

"Faster-than-expected yields pick-up could see leveraged positions in the bond market be squared and there is a risk of a snowball effect," said Hao Hong, managing director for research at Bocom International Holdings Co. in Hong Kong. "Rising rates are negative for equities," while the yuan will probably weaken further as the authorities continue to gradually reduce leverage in the bond market, Hong said.

— With assistance by Justina Lee, and Emma Dai

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