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--Yields on 10-year Chinese Govt Bonds Exceed Key Level for 1st Time in 3 Years
--Banks Stay on Sidelines Amid Funding Shortage
BEIJING (MNI) - The gloom in China's interbank bond market deepened this
week as the yield on the benchmark 10-year Chinese government bond (CGB)
breached the key 4% level for the first time in three years, and traders see
little prospect of any meaningful reversal over the short term.
The bear market that's had CGBs firmly in its grip over the past year amid
the government's campaign to force financial institutions to deleverage has been
exacerbated over the past few months as banks have lacked the firepower to buy
bonds and non-bank financial institutions, especially funds, have chosen to
focus on higher-yielding debt such as corporate bonds, as Money Week highlighted
The yield on the most-actively traded 10-year CGB, which matures on Aug. 3,
2027, rose by 11 basis points in two days, jumping from a closing level of 3.90%
last Friday to 4.01% on Tuesday afternoon, the biggest two-day jump since the
end of October, before falling back to 3.9350% on Friday afternoon after the
central bank threw money into the interbank market. It added a net CNY810
billion via open-market operations from Monday to Friday, although taking
account of CNY189 billion of maturing Medium-term Lending Facility loans, the
net total amounted to CNY621 billion.
"I think the market has gone into panic mode," a Beijing-based bond trader
with an asset management firm told MNI. "I just can't see a rational explanation
for this sudden jump in yields. October economic data came out on Tuesday and
the numbers were weaker so yields shouldn't be going up like this."
There was a fleeting glimmer of good news for investors on Wednesday, when
an auction of seven-year government bonds produced a yield of 3.9644%, lower
than the 3.9896% yield in the secondary market. Some traders took this as a sign
that banks had begun to buy bonds. However, according to Deng Haiqing, the chief
economist at Jiuzhou Securities, banks "are under orders to make sure CGB and
policy-bank bond auctions are successful."
That is to say, weak demand in the primary market is bad news for the
secondary market, but positive signals coming from the primary market won't
necessarily translate into large-scale buying from banks in the secondary
Overall, analysts and traders are gloomy about the short-term outlook in
the absence of any obvious drivers to push bond prices higher and point to
several technical and regulatory factors that are likely to keep prices
"There is still space for bond yields to rise further," Li Huiyong and Qiu
Difan, analysts at Shenwan Hongyuan Securities, wrote in a report this week.
Although yields on 10-year CGBs have already risen around 135 basis points since
October last year, that's not a record surge, they said.
Based on previous bond bear markets, there could be more misery to come,
they said. In the 2006-2007 slump, yields rose by 170 basis points, and in the
two-year market correction that ended in February 2011, yields rose by 146 basis
points and jumped by the same in the 2012-2013 bear market, they said.
"So if the market follows previous patterns, 10-year CGB yields could rise
as high as 4.05% to 4.35%," Li and Qiu said.
Analysts at Hua Chuang Securities warned investors to "be well prepared for
a continued rise in government bond yields, which will remain above 4% for a
CGB yields at this level should make them more attractive to long-term
investors, mainly banks that would normally wade in to calm and stabilize the
market. But recently they didn't show up.
Yields on three-month CGBs, which carry very little interest-rate risk and
so are a good reflection of demand from banks, have jumped this quarter, rising
from 3.2192% on Oct. 9, when the market re-opened after a holiday that began on
Sept. 30, to 3.6317% on Thursday this week, the highest since October 2014. That
suggests banks have little firepower to buy bonds.
"The pressure on banks on the liabilities side of the balance sheet is
what's behind this weak demand even though at these levels bonds offer good
value in the long term," Sun Binbin and Tang Xiaotian, analysts at Tianfeng
Securities, said in a report on Wednesday, pointing out that growth in bank
deposits this year has fallen significantly, constraining banks, the biggest
players in the interbank market, from buying bonds.
Data from the People's Bank of China shows that outstanding bank deposits
have risen 9.1% y/y as of October, lower than the 11.5% increase in the same
period last year.
The government's crackdown on leverage has made it harder and more
expensive for banks to raise funds in the interbank market through the issuance
of negotiable certificates of deposit (NCDs), and has crimped demand for NCDs
among other financial institutions.
"We can see from the third-quarter earnings reports of publicly listed
banks that their interbank assets are contracting," China International Capital
Corp. (CICC) said in a report this week. "Some of that is accounted for by a
decline in so-called idle funds in the banking system, and the impact from that
should be limited. But the rest of the funds ultimately go to the real economy,
so the contraction has led to a drop in corporate deposits."
Another manifestation of the pressure on bank liabilities is the difference
in the growth rates of M2 money supply, which reflects the growth in deposits,
and new loans.
"Currently, the gap between M2 growth and loan growth is at one of the
lowest levels on record," the CICC analysts wrote. "History shows that when M2
growth is lower than loan growth, banks' ability to buy bonds will be limited
and bond yields will then rise. So there is a negative relationship between this
gap and yields."
Every month this year, M2 growth has been smaller than the increase in new
lending. The gap has widened from 1.3 percentage points in January this year to
4.2 percentage points in October, the widest since September 2009, when the gap
was 4.8 percentage points.
Yields on NCDs have also risen sharply recently, another sign of pressure
on banks. They are having to offer higher yields to entice buyers as they boost
sales to refinance maturing certificates and raise new money as other avenues of
funding dry up under the deleveraging campaign. The yields on three-month NCDs
issued by joint-stock banks jumped from 4.7000% last Friday to 4.8890% this
Friday, the biggest weekly jump since February, while net issuance of NCDs this
week was more than CNY90 billion, the highest since early September.
Given all the pressure on the banks from so many different directions,
traders say it's unlikely the bear market will end soon if banks can't get
enough money to buy bonds.
"Banks' funding capabilities might improve if local government bond
issuance slows down or loan demand weakens," a Beijing-based bond trader at a
securities company told MNI. "But there are two important factors working
against the banks -- they have low excess reserves and short-term yields,
especially on money-market funds, are high, which is attracting deposits to flow
out of the banks. Neither of these factors are likely to change in the short
term and will continue to constrain the banks' ability to buy bonds."
Some analysts say there are signs that demand for loans could soften as
economic growth slows and the government follows the spirit of Xi Jinping's
report to the 19th Party Congress, which emphasized quality over speed.
"We clearly feel that the government is paying more attention to the
quality of economic growth now, rather than the quantity," Li Qilin and Zhong
Linnan, analysts at Lianxun Securities, said in a report this week. "This means
that irrational demand for funding will be restrained next year," which points
to lower demand for loans.
But local government bond issuance will probably remain elevated and the
pressure will be greatest in the second quarter of next year. Li and Zhong
estimate that some CNY3.48 trillion of bonds will be issued under a program
started in 2015 to allow local governments to swap the more expensive debts of
their local government financing vehicles into cheaper municipal bonds before
On top of that, there could be as much as CNY1.2 trillion of special
construction bonds in the pipeline for 2018, as well as expected local
government bond issuance of CNY830 billion.
That will take the total issuance of local government bonds to about CNY5.5
trillion, lower than 2016 but higher than 2017, they said.
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