June 12, 2020 / 6:23 AM / a month ago

Spike in China bond yields points to shift in stimulus strategy

SHANGHAI/SINGAPORE, June 12 (Reuters) - A spike in Chinese bond yields in an economy battered by the coronavirus pandemic is stirring expectations authorities want to stifle risky financial bets and guide cheap funding provided by banks into the real economy.

Money market and bond yields climbed this week to their highest levels in months, triggered in large part by a People’s Bank of China (PBOC) decision to refrain from further lowering the cost of its short-term loans to banks.

Yields on benchmark one-year government bonds have jumped to 2.09%, their highest levels since mid-March and up more than 85 basis points in a month. Repo and swap rates have also climbed.

The central bank proposed buying back loans from banks to help spur lending to small businesses, a sector of economic concern for China’s leaders, which pointed to the authority taking more direct action to achieve its aims.

“The central bank’s new tool emphasises its directness, aiming to lead fast growth in credit expansion at small and micro enterprises. And such expectations were the main reason causing selloffs in the bond market,” said Ming Ming, head of fixed income research at CITIC Securities in Beijing.

Analysts think the PBOC moves are aimed at discouraging investors from using billions of yuan of stimulus money for arbitrage trades or to take on excess debt.

HSBC analysts noted the central bank had permitted a rise in interest rates, saying “its behavioural shift was likely triggered either by the exchange rate, or financial risks, or both.”

A collapse in long-term yields between January and April suggested traders were purchasing government bonds and a jump in structured deposits at banks pointed to investors using cheap funds to profit off high-yield deposits.

Outstanding structured deposits jumped 26% to 12.14 trillion yuan ($1.72 trillion) in the first four months of 2020 .

“They have been raising front-end rates to essentially try to minimise the opportunity for this arbitrage, and for these carry trades,” said George Efstathopoulos, a portfolio manager at Fidelity Investments.

Tighter cash supply has also helped put a floor under the yuan , which has been weakening on concerns over the growing divisions between Beijing and Washington on issues ranging from the autonomy of Hong Kong to the coronavirus response.

Forward pricing for the yuan against the dollar has risen, making it more expensive to short the yuan, while higher yields on bonds could draw more foreign investors into mainland markets.

“In an indirect way, by having higher rates you are increasing the carry as well, so that definitely would be a supportive environment for the currency even though that might not be the primary tool at this stage,” said Karan Talwar, emerging market fixed income specialist at BNP Paribas Asset Management in Hong Kong.

Reporting by Winni Zhou in Shanghai, Tom Westbrook in Singapore and Swati Pandey in Sydney Editing by Vidya Ranganathan and Neil Fullick

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