(Bloomberg) -- China’s decision to step into its government-debt market shows that officials are willing to act to curb a relentless bond rally, but it raises new questions about efforts to stimulate the world’s second-largest economy.
The People’s Bank of China sold long-dated bonds and bought short-maturity securities in a move that resulted in a net purchase of 100 billion yuan ($14 billion) of debt in August, according to a statement on its website Friday.
The trades may help curtail aggressive gains in the nation’s bonds that have pushed benchmark yields to a record low as investors bet the central bank will ease monetary policy to support the economy. The scale and speed of the surge in bonds has prompted hand-wringing given the potential for a market meltdown if the money that has poured into Chinese debt rapidly reverses. However, market watchers said the new actions run counter to existing efforts to support sluggish domestic growth.
“It’s more about managing financial stability risks than the economy,” Win Thin, global head of markets strategy at Brown Brothers Harriman in New York, said of the PBOC’s operations. “If they want to stimulate the economy, they’d be pushing both ends of the yield curve down. Instead, it seems they are worried about a huge pile of one-way bets on bonds.”
The central bank stopped short of specifying the tenors of the debt it traded or the dates of its operations in its statement. But its actions could help push up longer-term yields relative to short-term rates, steepening the yield curve and easing the flows into fixed-income assets.
Concerns over a slowing economy, expectations for interest-rate cuts, and a lack of attractive investment alternatives have led investors to pile into Chinese government bonds this year. Yet officials have sought to ensure that such flows don’t become a crowded trade that would be vulnerable to a painful reversal.
After starting with just verbal warnings earlier this year, the PBOC’s pushback against the bond rally became more active in recent weeks. Debt sales by state banks to drive up yields and repeated regulatory checks on some investors have kept traders on edge and dampened activity.
In July, it said it had “hundreds of billions” worth of yuan of the securities at its disposal through agreements with lenders — a statement seen as a sign it was ready to sell them to tame the rally. Bets that the PBOC was preparing to trade debt then reached fever pitch this week after the central bank created a new section on its website on the buying and selling of government bonds.
Competing Goals
Policymakers now face an uphill battle as they juggle to achieve the “contradictory” mandates of supporting the economy — as well the nation’s currency and bond yields, said Rory Green, the chief China economist at TS Lombard.
“The PBOC is trying to muddle through driving economic growth, but also achieving these political objectives of a stronger renminbi and higher long-end yields,” Green said. “It’s fighting economic gravity, as it were, and the flows into fixed income that aren’t likely to diminish.”
For now, he said, “given the macro weakness, the flows into the market, it looks like a good time to buy any rise in yields.”
What Bloomberg Strategists Say...
“Policymakers have more to do on top of bond trading to support yields and divert the economy from its deflationary track.”
—Simon White, macro strategist at MLIV in London
Still, PBOC Governor Pan Gongsheng and his predecessor Yi Gang have both spoken about their desire to maintain a “normal, upward sloping” yield curve in recent years.
Unlike peers such as the Federal Reserve or Reserve Bank of Australia, which accumulated sizable debt portfolios through various quantitative easing programs before subsequently reducing their balance sheets, the PBOC has been a rare visitor to the bond market. The Fed via “Operation Twist” in the early 2010s and the Bank of Japan, more recently, have also also sought to influence the slope of their sovereign yield curve.
To Bob Savage, BNY’s head of markets strategy and insights in New York, the PBOC’s bond operations likely won’t have the same staying power as those seen in the US or Japan.
“This is a very different set of circumstances for the Chinese,” he said. “It might be more about how liquidity and money work in their system over the short-term and long-term.”
Friday’s announcement is nonetheless the clearest sign yet that the PBOC is considering making government-bond trading a regular tool to manage liquidity, something President Xi Jinping was cited as discussing in a book of previous remarks published in March.
Such an approach would give the central bank more flexibility to ensure ample cash supply, just as the room for using traditional tools such as adjustments of the reserve-requirement ratio is shrinking.
By buying sovereign notes on a net basis, the PBOC effectively injected liquidity into the financial system this month. The size of the infusion roughly matches the amount of cash the central bank drained with its medium-term lending facility on Monday.
“Such operational twist will allow PBOC to expand the balance sheet, inject liquidity, but — at the same time — keep the yield curve steep and upward sloping,” said Becky Liu, head of China macro strategy at Standard Chartered Bank HK Ltd.
--With assistance from George Lei.
(Adds comments from TS Lombard, BNY and BBH.)
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