China Central Bank Takes Bold Action to Control Bond Market Bubble

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For several weeks, the People’s Bank of China (PBoC) has been sounding alarms about a potential bubble in the sovereign bond market. Now, the central bank has shifted from verbal warnings to direct intervention, a rare move not seen in decades.

On Friday, the PBoC announced it had entered agreements with various institutions to borrow hundreds of billions of renminbi in long-dated bonds, which it plans to sell in the market to satisfy growing demand. The central bank stated that it would continue this borrowing and selling on an open-ended and unsecured basis.

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These actions signify the central bank’s firm resolve to curb the rush into sovereign bonds, a trend that has driven yields—moving inversely to prices—to historic lows. The PBoC is particularly concerned that eager buyers, including regional banks, could face significant trouble if yields spike abruptly, potentially slashing the value of their holdings and triggering a crisis akin to the collapse of Silicon Valley Bank last year.

Initial market reactions suggest some impact from the PBoC’s signals. Yields on 10-year debt, which hit an all-time low of 2.18 percent last week, inched above 2.3 percent on Monday after the central bank announced it would commence temporary bond repurchases, also known as reverse repo operations, to mitigate interbank interest rate volatility.

Despite these measures, some analysts question whether the PBoC can counteract bond demand indefinitely, considering that this demand stems from a struggling economy beset by a property downturn and sluggish equity markets. Investors currently have few appealing alternatives for their cash under these conditions.

Julian Evans-Pritchard, head of China economics at Capital Economics, expressed skepticism, noting in a recent report, “The forces pushing down long-term yields are mostly structural, and we doubt that they will reverse any time soon.”

Since April, the PBoC has repeatedly warned against the bond-buying frenzy. In mid-June, PBoC Governor Pan Gongsheng declared yields were too low, while other central bank officials asserted that the ideal range for 10-year government bond yields should be between 2.5 percent and 3 percent.

The renewed intervention in the bond market marks a significant shift from earlier central bank strategies. During periods of rapid economic growth, the PBoC could influence banks by controlling lending supply. However, as demand for credit has slowed and banking liquidity has shifted into bonds and other assets, the central bank has had to adapt its approach.

This shift is increasingly critical as China plans to issue trillions more in renminbi-denominated long-dated bonds in the coming years to bolster central government leverage and spending. Currently, the PBoC holds Rmb1.52 trillion in government bonds, mostly with shorter maturities.

Chen Long, co-founder of Beijing-based consultancy Plenum, likened the PBoC’s strategy to the yield curve control used by the Bank of Japan over the past decade. However, while the BoJ aimed to set a yield ceiling, the PBoC appears to be creating a yield floor.

The specifics of the PBoC’s operations remain ambiguous, including the timing, size, cost, and frequency of its bond trades. Richard Xu, chief China financial analyst at Morgan Stanley, suggested that the PBoC’s interventions would need to be thoughtful and measured, as market expectations can sometimes be swayed by mere verbal warnings, while other scenarios may require more decisive actions.

Gary Ng, a senior economist at Natixis, commented that the central bank was unlikely to fully commit to massive interventions. “It is more of a policy signal unless the intervention is massive, as the goal is to smoothen volatility rather than change the market trend.” Ng estimated the PBoC would probably need to buy at least 5 percent of outstanding government bonds to make a substantial impact, a less aggressive measure compared to the BoJ’s tactics.

Chen from Plenum noted a key element of Japan’s yield control was the BoJ’s unwavering commitment to purchasing unlimited bonds. If the PBoC truly intends to set a yield floor, it would similarly need to pledge to sell an unlimited amount of government bonds, though it remains uncertain if the central bank is prepared for such an extensive commitment or what its exit strategy might be.

Experts caution that increasing yields in China’s current deflationary environment will be challenging. New loan growth has slowed more than anticipated this year, and official data on total social financing—a broad measure of credit growth—showed a rare contraction in April, with a weaker-than-expected rebound in May.

Adding to the complexity is the tension between the PBoC and the finance ministry. Lower yields benefit the finance ministry by reducing bond issuance costs. A finance industry researcher at a state think-tank suggested that if the finance ministry had accelerated bond issuance earlier in 2024, the central bank would have issued fewer warnings.

In his report, Evans-Pritchard of Capital Economics concluded that even if the PBoC managed to influence long-term yields, the overall economic impact would be minimal, given the limited effect long-term rates have on corporate and household borrowing. “For now, the PBoC has retained a dovish tilt in its policy statements. What happens to policy rates and yields at the short end of the curve will remain more important for the economic outlook.”