Source – bloomberg.com
China has implemented an unconventional strategy to deter banks from purchasing government bonds, as authorities seek to halt the decline in yields and avert the risk of a bond market bubble. This week, China’s interbank regulatory body launched an investigation into four rural commercial banks for allegedly manipulating sovereign bond prices in the secondary market.
Investigation Targets Rural Banks
The investigation into the four rural commercial banks is widely interpreted as a warning to smaller regional lenders that have been aggressively buying government debt. This move follows an unexpected wave of bond sales by larger state-owned banks, which prompted these smaller institutions to step in and purchase the available bonds. The probe highlights the escalating tension between Chinese authorities and bond investors, as ten-year sovereign bond yields dropped to record lows earlier this week. The decline in yields, which move inversely to prices, reflects growing market concerns over China’s slowing economic growth and deflationary pressures.
Concerns Over a Potential Bond Market Bubble
While many countries would welcome strong demand for sovereign bonds, the People’s Bank of China (PBoC) has expressed concerns about a potential bubble forming in the market. Regulators have warned that the increasing appetite for long-term government debt among regional banks could trigger a crisis similar to the collapse of Silicon Valley Bank if yields were to suddenly spike. A bond trader from Jiangsu province reported receiving a call from the local PBoC branch advising against purchasing bonds, particularly when state banks are selling. The central bank’s concern is that a sudden rise in yields could have severe repercussions for banks heavily invested in long-term bonds.
Economic Implications and Government Response
China’s government is also trying to stimulate economic growth by encouraging regional lenders to allocate funds towards lending rather than investing in safe government bonds. The recent increase in benchmark ten-year yields, rising from a low of 2.12% to 2.15%, was attributed to significant bond sales by state banks.
Additionally, the fund industry regulator has slowed the approval of new funds focused on long-term sovereign bonds, aiming to curb excessive flows into government debt. Analysts note that China’s unusual public intervention in the sovereign bond market bubble suggests that further restrictions may be forthcoming as authorities attempt to manage the economic implications of prolonged low growth and weak inflation expectations.
