Zhou's Leverage Warning Sends China Bond Yield to 2015 High

Updated on
  • PBOC boss says firms have too much debt, opening old wounds
  • Run of stronger data stokes concerns over debt-fueled growth

Zhou Xiaochuan, governor of the People's Bank of China (PBOC), speaks during the Group of Thirty (G30) International Banking Seminar in Washington, D.C., on Oct. 15. 

Photographer: Olivier Douliery/Bloomberg

People’s Bank of China chief Zhou Xiaochuan has delivered a timely reminder that the country’s leverage issue hasn’t gone away -- and markets are paying attention.

Yields on China’s 10-year sovereign notes spiked to the highest level since April 2015 on a closing basis, while a stock gauge of smaller companies slumped the most in three months, after the PBOC governor voiced his concern at the weekend that Chinese firms have taken on too much debt. The comments come amid a run of strong data, with better-than-expected producer price growth Monday underscoring the image of an economy still riding the wave of unsustainable leverage to achieve its growth targets.

“Investors, who have always been concerned with tighter financial regulations, are now especially sensitive to news that’s negative for bonds, such as improvement in the economy,” said Liu Dongliang, a senior analyst at China Merchants Bank Co. in Shenzhen.

Read more: China Factory Inflation Rebounds Amid Continuing Capacity Cuts

Bonds and small-cap shares have borne the brunt of Beijing’s efforts to clamp down on leverage, after the country’s debt ballooned in the wake of the global financial crisis. Ten-year yields have climbed by more than 60 basis points this year, the most among major economies, with officials moving to curb shadow banking and corporate borrowing. The ChiNext gauge is still in the red for the year, even as big-cap stocks rallied.

Ten-year yields rose three basis points to 3.71 percent as of 5:04 p.m. in Shanghai, while the ChiNext closed 2.3 percent lower.

"Zhou Xiaochuan’s comments signal that China will move further to rein in financial leverage," said Shen Zhengyang, a Shanghai-based analyst with Northeast Securities Co. "That will hurt small caps with high leverage and weak earnings particularly.”

Zhou warns that Chinese corporate debt is too high.

Source: Bloomberg

Qin Han, chief bond analyst at Guotai Junan Securities Co. in Shanghai, said bond yields could climb to as high as 4 percent this year.

Diverging Fortunes

When the authorities started to ramp up the deleveraging campaign in April, equities and debt tumbled in tandem amid concern among mainland investors over the ramifications of the Politburo-backed push. The two markets have diverged in the past five months amid speculated buying by state-backed funds and as the economic outlook brightened. The benchmark Shanghai Composite Index closed at its highest level since December 2015 on Friday, and slipped 0.4 percent on Monday.

Measures of credit in the economy continue to show expansion, with aggregate financing at 1.82 trillion yuan ($277 billion) in September.

The consumer and producer-prices numbers are the last piece of data due before the start of the Chinese Communist Party’s congress on Wednesday, a once-in-five-years gathering where the leadership is reshuffled and priorities are set. China is due to update on third-quarter gross domestic product Thursday, with expansion forecast to come in at 6.8 percent for the period, down from 6.9 percent in the previous three months.

Zhou, who is nearing retirement age, has been markedly vocal in the run-up to the event, calling for market reform in an interview last week. In his comments over the weekend he also signaled that economic growth may surprise to the upside.

Here’s what analysts are reading into Zhou’s comments.

Yields may continue to rise in the near term, said Becky Liu, head of China macro strategy at Standard Chartered Plc.

“China is trying to find a balance between maintaining quick economic growth and cutting overall leverage,” she said. “These two forces, with one of them benefiting and the other hurting bonds, will work together to keep the debt market away from a one-way selloff. But if stock investors get even more optimistic, bonds will face more pressure."

— With assistance by Tian Chen, Helen Sun, Ye Xie, Enda Curran, and Justina Lee

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