China's bond market witnessed a remarkable rally on Monday, with the 10-year yield dropping below the crucial 2% psychological level. This significant event has sparked various discussions and analyses within the financial realm.
Unraveling the Forces Behind China's Bond Market Rally
Market Expectations and Stimulus Measures
The bond rally on Monday was mainly driven by expectations that Beijing could expand its stimulus measures to shore up the economy. Yields on China's 10-year government bond, which move inversely to prices, fell to 1.9636%, marking its lowest level in 22 years. 30-year bond yields also dropped to 2.164%. Tommy Xie, head of Asia macro research at OCBC Bank, stated in a note on Monday that the decline in yields is mainly due to expectations of a further cut to the reserve requirement ratio for commercial lenders. RRR determines the amount of cash that banks must hold in reserves. Additionally, he cited "supportive liquidity condition and still weak economic fundamentals" as factors helping drive the rally.The People's Bank of China's actions also played a significant role. Last Friday, it announced that in November, it had injected 800 billion yuan into the banking system via a so-called "outright reverse repo operation," which was ramped up from the 500 billion yuan injection in October. The move was aimed at "keeping liquidity in the banking system adequate at a reasonable level." Separately, the central bank also said it had purchased a net 200 billion yuan of government bonds in open market operations in November, aiming to "intensify counter-cyclical adjustment of its monetary policy."Authorities' Stance and Market Risks
Chinese authorities have attempted to stem the bond market rally as investment has piled into the safety of Chinese government bonds amid slowing economic growth and a lack of attractive investment options. The PBOC has cautioned about the risks of destabilizing bubbles as investors chase government bonds while shunning more volatile assets. Edmund Goh, investment director at abrdn, told CNBC that despite some encouraging signs of recovery in China's property market, "we didn't see any improvement in domestic economic data in the last few months." He stressed that lower yields reflected this economic situation and added that "without any meaningful fiscal stimulus, China will see the economy moving into a deflationary state."Global Comparisons and Equity Flows
China's 10-year yield remains far lower than the U.S. 10-year Treasury yield of over 4%. Eugene Hsiao, head of China equity strategy at Macquarie Capital, pointed out that "even though Chinese yields are now nearing 2%, the spread with U.S. 10 year yields has actually tightened." He added that this is a net positive for Chinese equity flows.China is expected to hold a closely-watched meeting by the Politburo, the top decision-making body of the ruling Communist Party, followed by an annual central economic work conference. At these meetings, Beijing is likely to announce additional stimulus measures, which may alter market dynamics and reduce the scope for further declines in yields. The resistance for further downside [on bond yields] may increase due to higher government bond issuance and upcoming major meetings.In conclusion, China's bond market rally and the subsequent market dynamics have attracted significant attention. The interplay between expectations, policy actions, and economic conditions will continue to shape the future of the bond market and have implications for various sectors and investors. READ MORE