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--Possible Stricter Rules Over NCDs Seen As Big Risk
--Bond Yield Inversion Points to Slack Long-Term Demand
BEIJING (MNI) - The Chinese bond market is likely to remain weak for some
time to come, given expectations that the government will further strengthen
regulation and amid relatively weak demand from long-term bond investors like
"Last year I bought as much as I could without hesitation when the 10-year
China government bond yields reached 3.0%," a Beijing-based bond trader at an
insurance company said, expressing concern for the bond market outlook. "But I'm
very afraid to buy now even when the yield is near 4.0%."
Beyond market structural concerns and overall weak market sentiment,
investors' worries over potential regulatory changes is the key factor behind
their cautious outlook.
In a survey conducted by Haitong Securities last week, 76% of bond
investors agreed that financial regulation is the main risk in the bond market,
much higher than other worries, including U.S. Federal Reserve interest rate
hikes, domestic inflation, tighter monetary policy and continued strong economic
conditions. Some 94% of the survey respondents believe financial regulation will
not be relaxed, with 37% of those predicting financial regulation will become
"Stricter financial regulation is likely to be the trend, so investors have
no way to alleviate their concerns," Jiang Chao, an analyst at Haitong
Securities, said on Tuesday. "The 19th National Congress report said the
economic growth model will shift from high speed to high quality ... implying
there won't be a flood of credit in the future."
Stronger regulation of the interbank market, especially concerning the
issuance and holding of negotiable certificates of deposit (NCDs), would have a
significant negative impact on the bond market.
"For banks, their interbank business is certainly a target for regulators,"
Jiang said. "If regulators tighten up their regulations of interbank NCDs, banks
will be forced to contract their liabilities and consequently force them to
contract their asset side, and government bonds are the easiest assets to sell."
"So stricter regulation will certainly cause CGB yields to go higher,"
This week, the yield of the most actively traded 10-year CGB, maturing on
Aug. 3 2027, dropped from 3.9050% at last Friday's close to 3.8650% on Thursday
before rising to 3.8800% on Friday, thanks to relatively good liquidity
conditions and a technical rebound after last week's sharp yield rise.
Banks and other financial institutions seeking long-term holdings may jump
into the market and slow the expected drop in yields, but not on a large-enough
scale to reverse the market trend.
"You can see the results of today's bidding for CGBs; the demand was quite
strong," a Beijing-based bond trader with one of China's "Big Four" state-owned
banks told MNI on Wednesday. "The price level seems quite attractive right now,
at least for us."
The Ministry of Finance sold one-year and 10-year CGBs on Wednesday at
yields of 3.54% and 3.82%, respectively, both lower than the secondary market
yields of 3.5791% and 3.8630% on the same day.
However, attractive prices do not guarantee that banks and other long-term
investors will buy in large quantities. The spread between five-year and 10-year
CGBs widened slightly from 112 basis points last Friday to 119 basis points on
Wednesday and then inverted on Thursday, indicating there has been insufficient
demand from long-term investors to steepen the curve to where it would normally
"Long-term investors will not just come in to buy [CGBs] or set an
attractive price level and buy as much as they can when the price falls below
that level," the Beijing-based bond trader said. "They will continue to watch
fundamental economic conditions and make their decisions" on when to buy.
In addition, banks may not be able to buy bonds in large amounts, analysts
"As the end of the year approaches, banks often issue bonds to prop up
their Tier 2 capital to meet regulators' demands for the capital adequacy ratio.
And banks often hold each other's bonds, and that uses up their bond investment
quotas," China International Capital Corporation (CICC) said in a report last
weekend. "Also, the bond price movements will affect their profit-loss books and
capital adequacy ratios, leading to weaker demand for bonds, especially those
with long durations."
The expected large amount of new bond supply in the fourth quarter will
only add further pressure on the market.
"The net issuance of government bonds, local government bonds and policy
bank bonds is not [usually] small in the fourth quarter. Meanwhile, as [banks
reaching their] loan quotas restricts loans, companies might turn to issuing
bonds to get financing," CICC said. "So investors need to look at the potential
risks that higher primary market yields will lead to higher secondary market
Looming additional bond supply isn't likely to motivate purchases by
short-term investors, who were burned by the last wave of rising long-term CGB
and policy bank bond yields and so are unlikely to bet on falling yields any
time soon, even though most analysts agree current long-term CGB yields are very
attractive for investors who can hold them for a long time.
However, two scenarios might present short-term trading opportunities in
the Chinese bond market worth bond investors' attention.
"First, if corporate bond yields begin to rise sharply, causing corporate
financing costs to rise, and so force net issuance of corporate bonds to fall
significantly, the PBOC might intervene to calm the bond market," Qin Han and
Xiao Chengzhe, analysts at Guotai Junan Securities, argued on Tuesday, referring
to the People's Bank of China.
"Second, if the PBOC follows the Fed and raises its interest rates in the
next two months, bond market yields might rise a lot. This could be seen as the
last bad news for the bond market, so investors could bet on a rebound of bond
prices following the rate hikes," Qin and Xiao said.
The PBOC injected a net CNY87 billion via open-market operations and
Medium-term Lending Facility (MLF) loans this week.
The benchmark seven-day deposit repo (drepo) averaged 2.8625% this week, up
from 2.8672% last week.
The yuan last traded at 6.6219 against the U.S. dollar on Friday,
strengthening from 6.6528 last Friday.
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