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Chinese Yields Fall on Diminished Rate Expectations

Chinese Yields Fall on Diminished Rate Expectations

2015-12-30 18:17:00
Renee Mu, Currency Analyst

- Chinese sovereign bonds surged to their highest level in two weeks.

- The yield of 10-year bonds surged to 2.80%, the lowest yield seen since January 2009.

- Additional rate cuts may be delayed until the second quarter of 2016.

Sina News

(China’s most important online media, similar as CNN in the US. Also, it owns a Chinese version of twitter, called weibo, with around 200 million active usersmonthly)

China’s 10-year bonds surged to their strongest level in two weeks. The Chief Economist ofthe PBOC’s research bureau, Ma Jun, said that any adjustments on the deposit reserve rate should avoid causing too much volatility to short-term rates. The scale and frequency of such adjustments should be determined in accordance with the target of maintaining the stability of short-term rates. If the deposit reserve rate fell too far and too quickly, it will lead to excessive cuts in short-term rates, which could eventually deepen capital outflows.

At the Central Economic Work Conference last week, officials released the monetary policy for the next year with a flexible overtone, hinting towards additional rate cuts in 2016. The news coming in today seems to send the signal that the PBOC has some concerns towards further easing. It does, however, give investors some clues that rates cuts in 2016 likely won’t happen very soon, and we may be looking towards the second quarter for that next cut.

If we look at it historically, there are only three instances with which Chinese government bonds saw yields drop to these levels if we include this instance. The other two are in 2002 and 2008-2009. The 2008-2009 low yields were in an environment of extremely loosened monetary policy in response to the Financial Collapse in the United States, and this led to abundant injection of liquidity. While in 2002, it was a different story: the monetary supply was stable but the demand for financing was shrinking. Sounds familiar, doesn’t it? We’ve previously discussed a similar situation that China is now facing - new yuan loans made by Chinese top commercial banks in October fell for the first time in six years, despite six interest rates cuts over the past 18 months.

This highlights that companies have less incentive to expand their business by borrowing money. In 2002, the primary driver of the Chinese economy was the development of real estate and China joining the WTO. Today, China is in a similar transition period and still exploring new market drivers. As a result, rushing to another rate cut may not necessarily promote credit issuance when the new the business cycle is ill-prepared to absorb the extra liquidity. Also, the international environment for China is different as well: The US Federal Reserve has raised rates in December after seven years of Zero Interest Rate Policy (ZIRP), and is expected to continue raising rates in 2016. As Chief Economist Ma said, this could “worsen capital outflows” if RRR is not carefully used.

Thus, additional rate cuts will likely happen according to the recent announcement of the monetary policy projections for 2016, but won’t likely take place until later in the year (towards Q2). One possible key driver for China’s economy is the projects under the One-Belt-One-Road initiative, which is to export China’s excess production and promote trade with neighbor developing countries. If those infrastructure projects go on well, companies may have increasing incentive to borrow and banks will gain confidence to lend out. That’s when the rate cuts will lead to more significant outcomes.

Written by Renee Mu, DailyFX Research Team

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.