The Chinese bond bonanza rolled on this week, sending yields down to levels not seen since the global financial crisis and helping to fuel concerns that the fixed income market is now being driven by the kind of debt-fuelled buying which laid waste to the stock market over the summer.
These concerns were heightened on Wednesday after the Ministry of Finance sold a 10-year bond at auction at a coupon rate of 2.9939%. The last time the 10-year was under 3% was January 2009. There were signs of cooling off towards the end of the week, with yields ticking back up, but traders don’t believe the market has turned yet, and that has them again concerned about another bubble in Chinese asset prices.
A Shanghai-based trader with a second-tier bank said this is a replay of the stock market bubble, except it’s institutions this time, not retail punters, who are borrowing to buy with little thought about risk.
“You don’t need fundamental analysis or an understanding of economic policy in this market — you just need to dare to take risk. This is no different to what happened happened in the stock market a couple of months ago,” he said.
Traders believe a bubble has formed in the bond market as a result of PBOC easing and in the wake of the flight to safety which followed the sharp plunge in stock prices over the summer. Heavy borrowing via the repo market is fanning the flames.
Seasoned market participants were warning at the start of autumn that prices were moving out of kilter with reality in a system-wide search for yield, and those dynamics haven’t let up.
“You need some kind of trigger to cause a sell-off but unfortunately, all the numbers we’re getting are only fuelling rising prices,” said a trader with one of the “Big Four” state-owned banks.
The National Bureau of Statistics said this week that the Consumer Price Index rose just 1.6% y/y in September, short of the median forecast of 1.8% and down sharply from 2.0% in August. The mood is unlikely to brighten on Monday, when the bureau is expected to announce that growth slipped to 6.8% in the third quarter, below 7% in the first half and under the government’s target for the full-year.
“Deflationary pressure is building. More easing is inevitable,” said Minsheng Securities in a note. A stabilizing yuan exchange rate has provided conditions for further monetary easing, the brokerage argued. Encouraging credit activity is the priority now and that argues for a rate cut even before another adjustment to the required deposit reserve ratio, it said.
There’s no question that the PBOC remains on an easing path, though the authority is continuing to struggle to manage the message. Last week’s announcement of an expansion of a regional relending program quickly morphed into speculation that China’s Quantitative Easing had finally arrived and would mean a CNY7 trillion liquidity infusion for the market.
The online chatter prompted a statement from Ma Jun, a former Deutsche Bank economist who has become a spokesman for the PBOC in his role as chief economist of its research bureau. Ma, whose appears to spend more time explaining what central bank policy isn’t, rather than what it is, denied that the relending program means QE and said liquidity levels in the system are adequate.
As with the stock market’s surge, few traders believe this bond market rally is sustainable. The market is overbought and now under threat from outflows headed back into a resurgent stock market, said Liu Dan, a Beijing-based bond analyst with Galaxy Securities. The likelihood that the Federal Reserve may now delay raising rates until next year only increase this risk of a correction, he said.
“Investors should be careful with liquidity uncertainty and deleveraging risks in the bond market as funds may be flowing back to the stock market,” he said.
Further out, plans to overhaul state-owned enterprises could see the government making good on its word and allow what it calls “zombie firms” to go to the wall.
“We should be near the end of falling yields. There will definitely be problems with corporate bonds should the government start shutting zombie companies next year and that will bring chain effects — sovereign bonds will get sold as well when the liquidity dries up, resulting in a quick rise in bond yields,” said Cheng Qingsheng, a Shanghai-based bond analyst with Hangfeng Bank.
The Chinese yuan weakened slightly this week but remains stable relative to the August and September’s volatility. It traded at 6.3580 on Friday afternoon compared with 6.3455 around the same time a week ago. Bloomberg reported this week that yuan trading hours will be extended to 2330 local/1530 GMT from 1630 by the end of November to capture the European trading day.
The government is pushing ahead with its campaign to have the yuan included in the basket used to measure the IMF’s Special Drawing Rights, despite clamping down on market trading in the wake of its August devaluation announcement.