China Watchers Caught Off Guard as Bond Rout Just Won't End

Updated on
  • No one knows how long this process will last: BNP strategist
  • Sovereign yield spikes as curve flattens on crackdown concerns

BlackRock's Rieder Says EM Traders Must Watch China

The ferocity of China’s bond rout is surprising some of the market’s top observers.

The yield on sovereign debt due in a decade surged to a two-year-high of 3.7 percent last week, wrong-footing analysts from Citic Securities Co. and Haitong Securities Co. --  the country’s two biggest brokerages -- who had in April predicted a maximum level of 3.6 percent in the near term. The tumble comes amid intensifying efforts to crack down on excessive borrowing, a drive that has beaten down stocks and pressured the yuan.

“No one knows what kind of indicator would suggest the campaign is over, and no one knows how long this process will last," said Shan Kun, head of China markets strategy at BNP Paribas (China) Ltd. in Shanghai. “When the market is so pessimistic, investors are trading based on expectations, and declines can be illogical.”

China’s government bonds advanced Monday, pushing the 10-year yield down three basis points to 3.62 percent in Shanghai. The nation will maintain a stable supply of liquidity to support appropriate expansion of credit, the central bank said in its quarterly monetary policy report released late Friday.

Here are three charts illustrating the extent of the pressure on Chinese debt:

Yield Spike

The 10-year sovereign yield surged 41 basis points in the last seven weeks amid policy tightening fears. The market is entering an “irrational mode” as recent economic data don’t support the selloff and regulators haven’t taken concrete deleveraging steps this month, Citic analysts led by Ming Ming wrote in a May 11 note titled "Finding Hope in Despair." The yield will peak at 3.80 percent by end-June, according to a Bloomberg survey this month. A similar poll in March had foreseen a maximum reading of 3.4 percent.

Curve Flattens

The one-year sovereign bond yield’s advance has outpaced that of the 10-year, with some traders dumping the shorter security amid speculation regulators will keep near-term borrowing costs high as part of the deleveraging campaign. The gap between the two has shrunk to near the least since 2013. An adjustment to such a flat curve will result in stronger pressures on the longer-tenor asset, Huachuang Securities Co. said this month. The one-year yield finished last week at 3.48 percent.

Company Strain

The extra yield that investors demand to hold top-rated five-year corporate bonds over the sovereign surged to a two-year high of 1.4 percentage points last week. Chinese firms canceled 120 billion yuan ($17.4 billion) of debt sales in April, the most in a year. China Vanke Co. -- the nation’s second-biggest residential developer with an AAA credit rating -- scrapped a total of 3 billion yuan of bond offerings on April 26.

— With assistance by Tian Chen, and Helen Sun

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