(Bloomberg) -- China bond traders have begun to test the limits of the central bank as a surprise interest-rate cut to buoy the economy also pushed yields down into a possible intervention zone.
The benchmark 10-year government yield slipped two basis points to 2.24% after an unexpected cut to the short-term policy rate by the People’s Bank of China. A Bloomberg survey had suggested 2.25% was a red line for the PBOC, who have been pushing back against a bond rally where yields hit a record low 2.18% earlier this month.
Investors will be on close watch for any response after the PBOC took a major step toward selling bonds to push yields higher a few weeks ago, announcing agreements with lenders to borrow securities to be sold. The central bank said at the time any action would depend on market conditions.
“There is no doubt that China needs lower rates for growth, and the market will likely continue to rationally expect this,” said Gary Ng an economist at Natixis SA in Hong Kong. “It is possible that the PBOC may intervene suddenly and try to manage yields at a range, but it will not fully deter the market force.”
China cut its seven-day reverse repo rate for the first time in almost a year as it steps up support for growth while at the same time shifting toward the short-term rate as a new policy benchmark. The shift will likely reduce the importance of the existing one-year benchmark, known as the medium-term lending facility rate.
In a separate statement Monday, the PBOC reduced the amount of collateral — namely bonds — that financial institutions need to pledge to access the medium-term facility. The move will help boost the amount of bonds available to trade in the market and ease the pressure on supply and demand, it said.
With the collateral adjustment, the PBOC “can increase the amount of bond inventory that could be sold on the market,” wrote Citigroup Inc.’s global head of emerging market economics Johanna Chua in a note. “It reflects an intention to keep a steeper yield curve while PBOC cuts policy rates.”
New Yield Normal
The monetary policy system revamp and a softer dollar will give China more room to cut rates, according to Becky Liu, head of China macro strategy at Standard Chartered Plc. That means a “new normal” for where government bond yields might trade, she said.
“People had thought 2.5% was the hard line for the 30-year CGB yield,” Liu said. “Now the new comfort level could as well be at 2.4%.”
China’s 30-year yield slipped one basis point to 2.45% on Monday.
For Frances Cheung, head of foreign-exchange and rates strategy at Oversea-Chinese Banking Corp. in Singapore, investor concerns about China’s growth trajectory will likely cap any rise in yields, even if the central bank acts.
The PBOC “may finally pull the trigger on bond selling under monetary operations,” Cheung said. “However, given the subdued risk sentiment and worries over the near term growth outlook, yields are unlikely to rebound strongly.”
(Updates with additional comments)
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