Finance

China’s bond market intervention reveals financial stability worries

Published

8 months ago

August 15, 2024

People walk past the headquarters of the People’s Bank of China (PBOC), the central bank, in Beijing, China September 28, 2018.

Jason Lee | Reuters

BEIJING — China’s latest efforts to stem a bond market rally reveals wider worries among authorities about financial stability, analysts said.

Slow economic growth and tight capital controls have concentrated domestic funds in China’s government bond market, one of the largest in the world. Bloomberg reported Monday, citing sources, that regulators told commercial banks in Jiangxi province not to settle their purchases of government bonds.

Futures showed prices for the 10-year Chinese government bond tumbled to their lowest in nearly a month on Monday, before recovering modestly, according to Wind Information data. Prices move inversely to yields.

“The sovereign bond market is the backbone of the financial sector, even if you run a bank-driven sector like China [or] Europe,” said Alicia Garcia-Herrero, chief economist for Asia-Pacific at Natixis.

She pointed out that in contrast to electronic trading of the bonds by retail investors or asset managers in Europe, banks and insurers tend to hold the government bonds, which implies nominal losses if prices fluctuate significantly.

Strategist explains why loan growth will be slow without China's property sector stabilizing

The 10-year Chinese government bond yield has abruptly turned higher in recent days, after falling all year to a record low in early August, according to Wind Information data going back to 2010.

At around 2.2%, the Chinese 10-year yield remains far lower than the U.S. 10-year Treasury yield of nearly 4% or higher. The gap reflects how the U.S. Federal Reserve has kept interest rates high, while the People’s Bank of China has been lowering rates in the face of tepid domestic demand.

“The problem is not what it shows [about a weak economy],” Garcia-Herrero said, but “what it means for financial stability.”

“They have [Silicon Valley Bank] in mind, so what that means, corrections in sovereign bond yields having a big impact on your sovereign balance sheet,” she continued, adding that “the potential problem is worse than SVB and that’s why they’re very worried.”

Silicon Valley Bank collapsed in March 2023 in one of the largest U.S. bank failures in recent times. The company’s struggles were largely blamed on shifts in capital allocation due to aggressive rate hikes by the Fed.

PBoC Governor Pan Gongsheng said in a speech in June that central banks need to learn from the Silicon Valley Bank incident, to “promptly correct and block the accumulation of financial market risks.” He called for special attention to the “maturity rate mismatch and interest rate risk of some non-bank entities holding a large number of medium and long-term bonds.” That’s according to a CNBC’s translation of his Chinese.

Zerlina Zeng, head of Asia credit strategy, CreditSights, noted that the PBoC has increased intervention in the government bond market, from increased regulatory scrutiny of bond market trading to guidance for state-owned banks to sell Chinese government bonds.

The PBoC has sought to “maintain a steep yield curve and manage risks arising from the concentrated holding of long-end CGB bonds by city and rural commercial banks and non-bank financial institutions,” she said in a statement.

“We do not think that the intention of the PBOC’s bond market intervention was to engineer higher interest rates, but to guide banks and non-bank financials institutions to extend credit to the real economy rather than parking funds in bond investments,” Zeng said.

Insurance hole in the ‘trillions’

Stability has long been important for Chinese regulators. Even if yields are expected to move lower, the speed of price increases pose concerns.

That’s especially an issue for Chinese insurance companies that have parked much of their assets in the bond market — after guaranteeing fixed return rates for life insurance and other products, said Edmund Goh, head of China fixed income at Abrdn.

That contrasts with how in other countries, insurance companies can sell products whose returns can change depending on market conditions and extra investment, he said.

“With the rapid decline in bond yields, that would affect the capital adequacy of insurance companies. It’s a huge part of the financial system,” Goh added, estimating it could require “trillions” of yuan to cover. One trillion yuan is about $140 billion USD.

“If bond yields move lower slower it will really give some breathing space to the insurance industry.”

Why the bond market?

Insurance companies and institutional investors have piled into China’s bond market partly due to a lack of investment options in the country. The real estate market has slumped, while the stock market has struggled to recover from multi-year lows.

Those factors make the PBoC’s bond market intervention far more consequential than Beijing’s other interventions, including in foreign exchange, said Natixis’ Garcia-Herrero. “It’s very dangerous what they’re doing, because losses could be massive.”

“Basically I just worry that it will get out of control,” she said. “This is happening because there [are] no other investment alternatives. Gold or sovereign bonds, that’s it. A country the size of China, with only these two options, there’s no way you can avoid a bubble. The solution isn’t there unless you open the capital account.”

The PBoC did not immediately respond to a request for comment.

China has pursued an economic model dominated by the state, with gradual efforts to introduce more market forces over the last few decades. This state-led model has steered many investors in the past to believe Beijing will step in to stem losses, no matter what.

The news of a local bank canceling a bond settlement “came as a shock to most people” and “shows the desperation on the Chinese government side,” said abrdn’s Goh.

But Goh said he didn’t think it was enough to affect foreign investor confidence. He had expected the PBoC to intervene in the bond market in some form.

Beijing’s yield woes

Beijing has publicly expressed concerns over the speed of bond buying, which has rapidly lowered yields.

In July, the PBoC-affiliated “Financial News” criticized the rush to buy Chinese government bonds as “shorting” the economy. The outlet later diluted the headline to say such actions were a “disturbance,” according to CNBC’s translation of the Chinese outlet.

Chang Le, fixed-income senior strategist at ChinaAMC, pointed out that the Chinese 10-year yield has typically fluctuated in a 20 basis-point range around the medium-term lending facility, one of the PBoC’s benchmark interest rates. But this year the yield hit 30 basis points below the MLF, he said, indicating the accumulation of interest rate risk.

The potential for gains has driven up demand for the bonds, after such buying already outpaced supply earlier this year, he said. The PBoC has repeatedly warned of risks while trying to maintain financial stability by tackling the lack of bond supply.

Low yields, however, also reflect expectations of slower growth.

“I think poor credit growth is one of the reasons why bond yields have moved lower,” Goh said. If smaller banks “could find good quality borrowers, I’m sure they would rather lend money to them.”

Loan data released late Tuesday showed that new yuan loans categorized under “total social financing” fell in July for the first time since 2005.

“The latest volatility in China’s domestic bond market underscores the need for reforms that channel market forces toward efficient credit allocation,” said Charles Chang, managing director at S&P Global Ratings.

“Measures that enhance market diversity and discipline may help reinforce the PBOC’s periodic actions,” Chang added. “Reforms in the corporate bond market, in particular, could facilitate Beijing’s pursuit of more efficient economic growth that incurs less debt over the long term.”

Finance

China’s response to U.S. tariffs will likely focus on stimulus, trade

Published

2 hours ago

April 3, 2025

Business Finance News

Chinese national flags flutter on boats near shipping containers at the Yangshan Port outside Shanghai, China, February 7, 2025.

Go Nakamura | Reuters

BEIJING — China’s reaction to new U.S. tariffs will likely focus on domestic stimulus and strengthening ties with trading partners, according to analysts based in Greater China.

Hours after U.S. President Donald Trump announced additional 34% tariffs on China, the Chinese Ministry of Commerce called on the U.S. to cancel the tariffs, and vowed unspecified countermeasures. The sweeping U.S. policy also slapped new duties on the European Union and major Asian countries.

Chinese exports to the U.S. this year had already been hit by 20% in additional tariffs, raising the total rate on shipments from China to 54%, among the highest levied by the Trump administration. The effective rate for individual product lines can vary.

But, as has been the case, the closing line of the Chinese statement was a call to negotiate.

“I think the focus of China’s response in the near term won’t be retaliatory tariffs or such measures,” said Bruce Pang, adjunct associate professor at CUHK Business School. That’s according to a CNBC translation of the Chinese-language statement.

Instead, Pang expects China to focus on improving its own economy by diversifying export destinations and products, as well as doubling down on its priority of boosting domestic consumption.

Watch for cascading tariffs as tariffs reroute trade within Asia, says economist

China, the world’s second-largest economy, has since September stepped up stimulus efforts by expanding the fiscal deficit, increasing a consumption trade-in subsidy program and calling for a halt in the real estate slump. Notably, Chinese President Xi Jinping held a rare meeting with tech entrepreneurs including Alibaba founder Jack Ma in February, in a show of support for the private sector.

The policy reversal — from regulatory tightening in recent years — reflects how Beijing has been “anticipating the coming slowdown or even crash in exports,” Macquarie’s Chief China Economist Larry Hu said in a report, ahead of Trump’s latest tariff announcement. He pointed out that the pandemic-induced export boom of 2021 enabled Beijing to “launch a massive regulatory campaign.”

“My view stays the same,” Hu said in an email Thursday. “Beijing will use domestic stimulus to offset the impact of tariffs, so that they could still achieve the growth target of ‘around 5%.'”

Instead of retaliatory tariffs, Hu also expects Beijing will focus on still using blacklists, export controls on critical minerals and probes into foreign companies in China. Hu also anticipates China will keep the yuan strong against the U.S. dollar and resist calls from retailers to cut prices — as a way to push inflationary pressure onto the U.S.

China’s top leaders in early March announced they would pursue a target of around 5% growth in gross domestic product this year, a task they emphasized would require “very arduous work” to achieve. The finance ministry also hinted it could increase fiscal support if needed.

About 20% of China’s economy relies on exports, according to Goldman Sachs. They previously estimated that new U.S. tariffs of around 60% on China would lower real GDP by around 2 percentage points. The firm still maintains a full-year forecast of 4.5% GDP growth.

Changing global trade

What’s different from the impact of tariffs under Trump’s first term is that China is not the only target, but one of a swath of countries facing hefty levies on their exports to the U.S. Some of these countries, such as Vietnam and Thailand, had served as alternate routes for Chinese goods to reach the U.S.

At the Chinese export hub of Yiwu on Thursday, businesses seemed nonchalant about the impact of the new U.S. tariffs, due to a perception their overseas competitors wouldn’t gain an advantage, said Cameron Johnson, a Shanghai-based senior partner at consulting firm Tidalwave Solutions.

He pointed out that previously, the U.S. had focused its trade measures on forcing companies to remove China from their supply chains and go to other countries. But Chinese manufacturers had expanded overseas alongside that diversification, he said.

“The reality is this [new U.S. tariff policy] essentially gives most of Asia and Africa to China, and the U.S. is not prepared,” Johnson said. He expects China won’t make things unnecessarily difficult for U.S. businesses operating in the country and instead will try harder to build other trade relationships.

Since Trump’s first four-year term ended in early 2021, China has increased its trade with Southeast Asia so much that the region is now Beijing’s largest trading partner, followed by the European Union and then the U.S.

The 10 member states of the Association of Southeast Asian Nations (ASEAN) joined China, Japan, South Korea, Australia and New Zealand in forming the world’s largest free trade bloc — the Regional Comprehensive Economic Partnership (RCEP) — which came into being in early 2022. The U.S. and India are not members of the RCEP.

“RCEP member countries will naturally deepen trade ties with one another,” Yue Su, principal economist, China, at the Economist Intelligence Unit, said in a note Thursday.

“This is also partly because China’s economy is likely to remain the most — or at least among the most—stable in relative terms, given the government’s strong commitment to its growth targets and its readiness to deploy fiscal policy measures when needed,” she said.

Uncertainties remain

The extent to which all countries will be slapped with tariffs this week remains uncertain as Trump is widely expected to use the duties as a negotiating tactic, especially with China.

He said last week the U.S. could lower its tariffs on China to help close a deal for Beijing-based ByteDance to sell TikTok’s U.S. operations.

But the level of new tariffs on China was worse than many investors expected.

“Unlike some of the optimistic market forecasts, we do not expect a US-China bilateral grand bargain,” Ting Lu, chief China economist at Nomura, said in a note Thursday.

“We expect tensions between these two mega economies to worsen significantly,” he said, “especially as China has been making large strides in high-tech sectors, including AI and robotics.”