(Bloomberg) -- China’s intervention in the nation’s government bond market is leading to abnormalities across the curve, from a surge in trading of non-benchmark “special” securities to a slump in yields on short-maturity debt.
Transaction volume of a 10-year bond the central bank may have sold in order to intervene in the market surged eightfold on Tuesday and it’s now the second most actively traded sovereign note, according to official data. Meanwhile, suspected buying by the authorities sent one-year yields below the overnight borrowing rate.
The central bank’s ultimate goal may be to make the so-called sovereign yield curve steeper by enlarging the long-end bonds’ yield premium over their short-dated peers, so it can limit speculation in the debt market while keeping borrowing costs low. The often opaque operations have kept traders on tenterhooks as they make the outlook of a blistering bond rally less certain despite China’s economic malaise.
“Bond buying and selling under monetary operations are unlikely to alter the overall direction of market trading,” said Frances Cheung, head of foreign-exchange and rates strategy at Oversea-Chinese Banking Corp. “But it may put an interim floor to long-end yields and help maintain the spreads between short-end and long-end yields.”
For days, state lenders were seen selling a special sovereign bond that’s mostly owned by the People’s Bank of China, a sign the authorities are seeking to slow the decline in long-term yields, according to traders. The move helped to drive the turnover on the debt to 16.6 billion yuan ($2.3 billion) on Tuesday, compared with just 2.2 billion yuan in the previous session.
On the other hand, the banks were also buying short-dated notes, lowering the front-end yields, traders said. That sent one-year yield to a level that’s nearly 60 basis points below the overnight repurchase rate on Tuesday, the widest gap since 2021. Such discount is rarely seen and suggests it’s loss-making for traders to buy bonds with borrowed cash.
The operations chime with what the PBOC did in August, when it also purchased short-end notes and sold long-dated ones. The traders asked not to be identified as the information was private.
“Such an operation will likely to continue and lead to likely consistent bids for short-dated Chinese government bonds,” said Becky Liu, head of China macro strategy at Standard Chartered Bank Plc. “The short-dated bond purchase is needed to keep PBOC balance sheet expanding — or at least not shrinking — and making sure the PBOC is injecting rather than withdrawing liquidity from the market.”
Behind the authorities’ moves are a set of seemingly contradictory goals: While they need to lower borrowing costs to help boost demand in the economy, they also want to avoid a liquidity-fueled bond bubble that can undermine growth. On top of direct intervention, Beijing also delivered multiple verbal warnings to speculators and convened financial institutions for meetings to warn of risks.
Officials are also wary of the 2023 collapse of Silicon Valley Bank which piled into US Treasuries before a market reversal.
A confluence of factors, including bets for monetary easing and a lack of attractive investment alternatives have contributed to gains in government bonds this year. Despite the officials’ pushback, China’s benchmark 10-year yield slid to a fresh record low this week.
The yield gap between one and 10-year yield stood at 76 basis points, compared with just 25 basis points in December.
“The PBOC has to buy more short-dated Chinese government bonds, if they continue to intend to sell more long-dated bonds in order to keep the yield curve steep,” said Liu.
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