China's Long-End Bond Selloff Suggests Central Bank Relief Won't Last

Updated on
  • Ten-year yield has risen even as short-end has fallen
  • Central bank will let banks use reserves during holiday

A jump in Chinese short-end bonds is no reason for traders to celebrate.

Relief was palpable in the market this week after typical year-end liquidity tightness passed and the central bank said it will let banks use reserves to meet funding needs during February’s week-long Lunar New Year holidays. The one-year government bond yield has plunged 18 basis points since markets re-opened in the new year, set for the biggest weekly slide since June 2015, when China slashed rates. Yet the 10-year yield has kept climbing, causing the yield curve to steepen sharply.

The failure of the 10-year yield to follow the short-end lower suggests traders are still bearish on the factors that made China one of the world’s worst-performing bond markets in 2017. Commodity prices are rising, the U.S. is still on a tightening path, and the People’s Bank of China has skipped cash injections for 10 straight days, a sign it’s reluctant to ease funding conditions significantly.

“The PBOC’s maneuver shows on the short end, it’s guaranteeing that you won’t have any problems,” said James Yip, a Hong Kong-based money manager at Shenwan Hongyuan Asset Management. “If people are more upbeat cyclically, it means their expectations are more optimistic about the economy and inflation, which is a worry for the long end. Plus you still can’t see any loosening or resolution in the whole regulatory framework.” 

For now, the money market is enjoying a reprieve. The seven-day repurchase rate slid to the lowest since April on Thursday, despite net liquidity withdrawals by the central bank.

Inflation Risk

But the bigger picture hasn’t changed much. China’s economic data have been mostly steady, and a gauge of commodities hit a 10-month high Friday, increasing the risk of faster inflation. The latest set of Federal Reserve minutes show gradual U.S. tightening is still on track, giving China some pressure to follow suit.

And in a sign curbing financial risks remains an official goal, policy makers tightened supervision of entrusted bond holdings to curtail leverage, people familiar with the matter told Bloomberg News on Thursday.

Investors “are still very much worried about funding conditions before the Spring Festival and regulations, so they’ve concentrated their holdings in short-end ‘haven’ types,” Qin Han, a fixed-income analyst at Guotai Junan Securities Co., wrote in a note. “Although funding conditions are extremely loose, investors have been scared stiff.”

— With assistance by Ling Zeng

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