Joe McConnell
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China has adopted an unusual tactic to discourage banks from buying government bonds as authorities seek to stem an unwelcome decline in yields and prevent the formation of a bubble: by denouncing and shaming buyers.
China’s interbank regulator announced this week it was launching an investigation into four rural commercial banks for “manipulating government bond prices in the secondary market.”
The investigation is widely seen as a rebuke to small regional lenders that bought government bonds aVsceker larger state banks unexpectedly began selling them.
It comes as the battle between Chinese authorities and the country’s bond investors intensifies this week. Yields on 10-year government bonds, which move inversely to prices, fell to record lows on Monday, a sign that markets are increasingly concerned about low growth and deflationary forces in the economy.
While buying sovereign bonds may be welcomed by many countries, the People’s Bank of China has repeatedly warned that a bubble is forming in the sovereign bond market, with regulators saying that regional banks’ appetite for long-term government debt risks triggering a Silicon Valley-style banking crisis if yields suddenly rise.
“The local branch of the PBoC called us and advised us not to buy bonds when state-owned lenders are selling,” a bond trader at a local lender in Jiangsu province said this week.
“They accused some rural banks in Suzhou of buying bonds sold by state-owned banks.” On Monday, big banks sold long-dated bonds worth a net RMB 22 billion, 10 times last week’s daily average, according to BNP Paribas securities market data.
The government is also trying to stimulate economic growth by pushing regional creditors away from putting their money in ultra-safe bonds and into lending it out.
Yields on the benchmark 10-year note edged up slightly from a record low of 2.12% seen earlier this week, rising to 2.15% on Thursday.
The moves come aVsceker the National Association of Financial Market Institutional Investors (NAFMII) said on Wednesday that some small lenders “committed irregularities.” In a separate announcement, NAFMII said it had launched an investigation into Jiangsu Changshu Rural Commercial Bank, Jiangsu Suzhou Rural Commercial Bank, Jiangsu Jiangnan Rural Commercial Bank and Jiangsu Kunshan Rural Commercial Bank for potential manipulation of the government bond market.
Analysts said it was rare for NAFMII to publicly address the issue of sovereign bond trading, suggesting further restrictions could follow.
“Some policy makers seem to consider long-term interest rates low [government bond] yields as a sign of low expectations for domestic growth and inflation expectations, and would like to counter this pessimistic sentiment,” Goldman Sachs analysts said in a recent note to clients.
In July, the PBoC struck a deal with Chinese financial institutions that allows it to borrow several hundred billion renminbi of long-dated bonds and sell them on the market. But there is still little evidence that the central bank has used this new tool to combat the bond rally, which has been driven by investors’ hunger for safe-haven assets in a weakened economy mired in a prolonged housing crisis.
The country’s manufacturing activity fell for a third straight month in July, while export growth missed expectations last month in dollar terms.
Instead, authorities responded this week with a new round of warnings and market interventions.
Bond traders at mid-sized city commercial banks said the moderate rise in yields was the result of significant selling of seven- to 10-year bonds by state-owned banks, including the Industrial and Commercial Bank of China and the Bank of China.
In another move, the fund regulator slowed approval of new funds that track long-term sovereign bonds with maturities of more than two years, in a bid to curb flows into government debt.
“This is only for newly established funds,” said a Beijing-based bond fund manager at a major mutual fund firm. “There are still significant inflows into the sovereign bond market from existing bond funds.”
In May, China began selling 1 trillion renminbi ($140 billion) worth of long-dated bonds to finance its long-term economic transition.
