MNI: PBOC Wary Of Rapid Long-dated CGB Yield Decline

The People’s Bank of China will continue to monitor the longer-dated Chinese government bond market, adding supply and control over leverage to help guide the yield closer to the present 2.5% one-year medium-term lending facility rate, an advisor and economists told MNI.

The rapid and irrational fall of long-term CGB yields could trap liquidity in the financial system and raise the risk of a bond-market correction, said Li Peijia, head of the China financial team at the Bank of China Research Institute. A large amount of capital flowing into the bond market would also hinder credit expansion to the real economy, Li warned. (See MNI PBOC Watch: LPR To Hold, Idle Funds Targeted)

Regulators will likely strengthen administrative order and add control over bond-market leverage, she continued. Li attributed the bull market to the central bank’s easing stance, the sluggish A-share equity market and foreign investor’s renewed appetite for yuan-denominated bonds.

The central bank mentioned in its latest Monetary Policy Committee meeting that “attention should be paid to changes in long-term yields during the process of economic recovery,” an unexpected and unprecedented warning that many believe signalled the PBOC would not tolerate a rapid decline in long-term interest rates.

CGBs have rallied since November 2023, with 10-year and 30-year yields falling 40 basis points and 50bp in less than six months to 2.3% and 2.5% respectively. The 10-year debt yield dropped to 2.24% in early March, its lowest level in over a decade.

An advisor familiar with monetary policy told MNI the rapid drop of the 10-year CGB yield did not align with the PBOC’s desire for a steady yield curve and has also further widened the interest spread between China and the U.S. This will pressure the yuan, he explained, noting the PBOC is sending a warning to investors that the yield will edge up as the economic recovery remains on track. (See MNI: More Yuan Volatility Ahead, PBOC Vigilant)

Yields will also rise as authorities accelerate long-term bond issuance, such as state-owned policy bank debt and ultra long-term special treasuries, he added.

Ming Ming, chief economist at CITIC Securities and a former PBOC official, said the central bank's attention to changes in long-term yields may indicate its intention to maintain interest-rate stability rather than a reversal of its easing stance, considering its major task at present is lowering funding costs of companies and residents to boost credit demand as soft inflation has raised real interest rates. (See MNI INTERVIEW: PBOC To Cut Rates To Boost Credit - Zhang Bin)

FINANCIAL STABILITY

Small banks – particularly rural commercial institutions – have driven the long-term bond market bull run, buying CNY1.4 trillion in mostly the seven to 30 year maturities over Q1, more than securities companies and mutual funds, according to the China Central Depository and Clearing Co.

A commercial bank official said the sluggish property market, deflation risk and speculation on further policy easing had fuelled the rally. The lower CGB supply and ample liquidity had pushed yields down further, he added.

Necessity had also driven the increased allocations and duration extensions as the smaller banks felt pressure to compete with larger institutions for deposits amid a sluggish credit market, he said.

The policy advisor noted small- and mid-sized banks had systematically reduced their lending since 2022, which coincided with their increased bond allocations. Rural commercial banks, however, lacked risk-management capabilities particularly should CGB prices change dramatically, he argued, noting this created greater bond risk.

The official conceded the PBOC’s warning had aroused wide concern among small banks, prompting his institution to slow down CGB allocations following the yield runup in mid-March. However, commercial banks will likely continue to buy long-term CGBs, particularly after deposit rates fall, he added. Small banks previously covered high term deposit rates with equity products, but they now primarily do this via extending CGB duration, he explained.

Ming said the weighted-average cost of liability of rural commercial banks is now about 2.16%, lower than the 10- and 30-year yield.