Chinese authorities are taking extraordinary measures to tighten their grip on the world’s third-largest government bond market. In a highly unusual 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 has driven yields to record lows and raised concerns about banks‘ exposure to interest-rate risk.
The recent interventions seem to be achieving their intended effect, as the benchmark 10-year yield has risen from an all-time low of about 2.12% to around 2.25%. However, there is a risk that government meddling could disconnect the market from its economic fundamentals and erode long-term investor confidence. Previous interventions in shares and currency trading have deterred international money managers, as evidenced by the record amount of money withdrawn from China by foreigners in the second quarter.
Serena Zhou, a senior China economist at Mizuho Securities Asia Ltd., believes that while the measures have been effective in curbing speculation, the government must take more assertive monetary and fiscal actions to combat deflation expectations. The dilemma facing Beijing is balancing the need to support the sluggish economy with keeping borrowing costs low while preventing the formation of a bond bubble that could threaten financial stability.
Recent measures include Chinese brokerages scaling back government bond trading, state banks recording details of bond buyers, and regulators urging caution among financial institutions to limit risks. Despite these efforts, investors are still waiting for the People’s Bank of China to enter the market and sell government debt it holds through agreements with lenders.
China’s government bonds have seen a surge in demand this year due to the gloomy economic outlook and expectations of interest-rate cuts. The lack of attractive investment alternatives and a shift from savings to financial investments have further fueled this demand. Pictet Asset Management believes that Chinese onshore bonds should be part of global investors‘ diversified portfolios, citing their lack of correlation to other markets and the country’s strong economic fundamentals.
In conclusion, while Chinese authorities are taking drastic measures to control the government bond market, the long-term impact remains uncertain. The intervention may temporarily affect bond yields, but ultimately, economic fundamentals will determine their trajectory. Investors should consider the unique opportunities presented by Chinese government bonds amidst global market volatility and economic uncertainty.