MNI: Sluggish Economy To Hinder PBOC's CGB Interventions

The People’s Bank of China’s moves to deleverage the fixed-income market and cool the bond rally will likely have little impact on the downward momentum of CGB yields thanks to the sluggish economic recovery, policy advisors and traders told MNI, noting the Bank wanted to temper speculation rather than reverse the bullish trend.

A bond trader in Beijing noted large state-owned banks had begun selling treasuries on Aug 5 when the 10-year yield dropped to a 20-year low to 2.08%. Similar selling occurred over the following days when the banks sold mainly 10- and seven-year CGBs, he added.

The yield on 10-year CGBs has jumped 13 basis points to 2.25% since Aug 7, while the interest on 30-year bonds surged 10bp to 2.44%.

The trader noted the sales, combined with the PBOC’s interbank liquidity squeeze, drove the recent bond market weakness. (See MNI: PBOC Eyes Lower Rate For GDP Target, RRR Cut Optional)

WINDOW DRESSING

The state-owned banks were following the PBOC’s so-called window-guidance order, which likely required them to sell treasuries when the 10-year yield dropped below 2.25%, the trader said, predicting the central bank wanted them to remain between 2.25-2.3%.

The intervention via the banks was unexpected as the PBOC had warned repeatedly it would act as the CGB seller following comments on July 1 that it would borrow bonds from lenders. (See MNI: PBOC Eyes CGB Selling To Curb Bull Bond Market)

An advisor familiar with monetary policy operations told MNI the market should not underestimate the PBOC’s desire to curb long-term yields, whether that occurred by selling bonds directly or via the major banks. He argued 10-year yields should trade within 2.5-3%, which was an acceptable range.

However, the central bank’s moves are likely targeted at speculation rather than reversing the rally as it wants to create policy space for further easing, including a cut to the reserve requirement ratio, in a bid to coordinate government-bond issuance, he added.

In its latest Q2 Monetary Policy Report issued on Friday, the PBOC reiterated its concerns about low bond yields, noting the 20-year-low 2.2% that 10-year CGBs reached in late June had “significantly deviated from the reasonable range.”

LIQUIDITY SQUEEZE

Insufficient liquidity supply has also discouraged bond investors. The Bank drained a net CNY760 billion via open market operations last week, the biggest weekly drain since March.

Money-market rates rose broadly on Monday as the injection failed to meet demand, the trader said. The overnight reverse repo rate climbed 16bp, while the 7-day rose by 9bp.

Liquidity demand remained robust considering the net CNY400 billion of government bonds issued between Wednesday and Friday last week, the trader continued, noting the PBOC had taught speculators a lesson.

A mutual fund analyst told MNI the central bank will likely conduct stress tests soon, aiming to push the 10-year CGB yield above 2.3%. Stop-loss orders and negative feedback could potentially drive 10-year bond yields to about 2.4%, even without major bank selling, should it break through 2.3%, he added.

The monthly economic data and the PBOC’s upcoming medium-term lending facility decision on Thursday will help gauge market reaction and test the central bank’s tolerance, the analyst commented.

NON-MARKET MEASURES

The National Association of Financial Market Institutional Investors, a self-discipline body under the PBOC, announced on Aug 8 an investigation into four rural commercial banks accused of manipulating secondary market treasuries prices, a move seen by many as the Bank’s attempt to punish aggressive bond buyers.

The analyst said yields could jump fast and high should the central bank successfully stymie rural banks, which have been the most active bond buyers in recent months. Non-banking institutions are likely the next target, he added.

A recent PBOC Report warned some wealth management products, particularly those heavily allocated to bonds, have used leverage to increase annualised returns, increasing underlying risk.

Mutual funds and securities firms were the primary bond sellers on Monday, while insurance companies were the main buyers, according to the trader, noting several market makers had halted operations for long-term treasuries with transaction volumes falling significantly.