Chinese authorities are taking drastic measures to tighten their control over the government bond market, which is the world’s third-largest. In a surprising move, regulators instructed rural banks in Jiangxi province not to settle recent purchases of government bonds, essentially reneging on their market obligations. This intervention is part of a series of actions aimed at cooling a market rally that drove yields to record lows and raised concerns about banks‘ exposure to interest-rate risk.
The impact of these interventions is already being felt, with the benchmark 10-year yield increasing from an all-time low of about 2.12% to around 2.22%. While the immediate goal seems to be achieved, there is a risk that excessive meddling by authorities could disconnect the market from its economic fundamentals and erode long-term investor confidence. Past interventions in shares and currency trading have had chaotic consequences, deterring international money managers from investing in Chinese assets.
Foreign investors have shown their skepticism towards Chinese assets by pulling a record amount of money from the country in the second quarter. This reflects deep-seated pessimism and highlights the challenges faced by Chinese authorities in balancing economic support with financial stability. The collapse of Silicon Valley Bank, which suffered losses due to rising rates, serves as a cautionary tale for China’s financial institutions.
Recent measures taken by Chinese brokerages to reduce trading of government bonds, along with regulators‘ requests for state banks to monitor buyers of sovereign notes, indicate a concerted effort to rein in speculation and limit risks. The People’s Bank of China’s branch in Shanghai has also engaged financial institutions to discuss bond market risks, underscoring the seriousness of the situation.
Despite the government’s efforts to manage the bond market, uncertainties remain. Trading volumes for the most active 10-year government bonds have declined significantly, signaling a cautious approach among investors. While state banks have been selling bonds, the market is awaiting action from the People’s Bank of China itself, which holds a substantial amount of government debt.
China’s government bonds have seen a surge in demand this year due to economic concerns and expectations of interest-rate cuts. The lack of alternative investment options and a shift towards financial investments have driven this trend. Pictet Asset Management believes that Chinese government bonds should be part of global investors‘ portfolios, citing their lack of correlation with other markets and the country’s economic fundamentals.
In conclusion, the Chinese government’s efforts to manage the government bond market reflect a delicate balancing act between supporting the economy and maintaining financial stability. While interventions may temporarily impact yields, the ultimate determinant will be economic fundamentals. Investors are advised to consider the unique characteristics of Chinese government bonds and their potential benefits in a diversified portfolio.