RPT-MNI Policy: PBOC Watching Bond Rally, Starts Stress Tests

(Story first published Aug 26)

MNI (BEIJING ) - The People's Bank of China is closely monitoring short-term inflows into the bond market as it continues to push back against what it sees as a risky decline in long-term yields, and has started stress tests on commercial banks to determine potential excessive exposures to changes in interest rates, MNI understands. 

The PBOC has been trying to curb an unprecedented bull run in China’s treasuries market since April, but it has so far not deterred investors from buying government debt as an alternative to a volatile stock market and a declining real-estate sector. (See MNI: Sluggish Economy To Hinder PBOC's CGB Interventions)

PBOC officials are now concerned that bond exposures at some institutions, particularly at small rural banks which have been among the most-aggressive long-term bond purchasers since 2022, now constitute a potential risk to financial stability.

In its quarterly Monetary Policy Report issued early this month, the Bank noted the 10-year government bond yield had significantly deviated from "a reasonable central level," pointing to interest rate risks at some wealth management products, which have achieved high returns via adding leverage. (See MNI: PBOC Eyes CGB Selling To Curb Bull Bond Market)

Financial News, a newspaper under the PBOC, cited “industrial insiders” in May saying that 2.5-3% was a reasonable range for long-term treasury yields. As of Aug 23, the yield on actively-traded 10-year treasuries closed at 2.15%, 30-years at 2.34%, and the seven-year at 2.04%. 

INTEREST RATE RISK

The Bank has issued warnings and tried to curb the bond rally since April, but the 10-year yield has still sunk by 50 basis points since December, hitting a record low of 2.12% on Aug 2. The 30-year yield declined by 50bp in the same period, from 2.98% in December. (See MNI: PBOC Wary Of Rapid Long-dated CGB Yield Decline)

The central bank considers that the market has become dangerously overstretched and that the trade is crowded, attributing the bond rally to the short supply of government bonds and the market's consistently weak view of falling bond yields.

The PBOC has also detected cases of illegal price manipulation, which it thinks have further fuelled the rally. Rural commercial banks and non-bank institutions have become the most active treasury buyers in the interbank market.

In June, PBOC Governor Pan Gongsheng said close attention must be paid to the "mismatch in duration and interest rate risks associated with the large holdings of medium- and long-term bonds by some non-bank entities," pointing to lessons from the collapse of Silicon Valley Bank in the U.S.

The PBOC insists that long-term treasury yields will start to rise, driven by accelerating government debt issuance over the rest of the year, and by the upward trend of the economy in the longer run. Authorities expect growth to average over 5% annually in coming years, making it unlikely for CPI to remain below 1% for an extended period.

To prevent potential instability when bond yields rise, the PBOC has started stress testing some banks, including both big and small institutions, to evaluate how they would withstand bond-yield volatility. It is examining their fixed-income exposure, alongside their capital and liquidity conditions, which will help regulators and bank managers identify vulnerabilities and take measures to mitigate risks.