(Bloomberg) -- The party’s over, let the games begin.
China watchers had long suspected that Beijing would be more tolerant of bigger market moves after the Communist Party’s once-in-five-years congress ended last week -- but the ferocity of the selloff in bonds and stocks took analysts by surprise.
Ten-year sovereign yields surged 20 basis points in four days to a three-year high before central bank liquidity injections -- amounting to just over 1 trillion yuan ($151 billion) this week -- halted the slide. Shares in Shanghai, meanwhile, are hurtling toward their biggest weekly drop in almost three months. Reasons for the stumble have varied, with, as is typical in China’s markets, speculation feeding off speculation to further fuel losses.
These are the main factors cited as being behind the slump:
- The Economy: People’s Bank of China Governor Zhou Xiaochuan said just before the start of the 19th Party Congress on Oct. 18 that growth may quicken to 7 percent in the second half. That went against the consensus for China to see a strong first half followed by moderate cooling. These comments helped trigger the surge in benchmark bond yields, which have climbed for a fourth week, the longest run of gains since May.
- Deleveraging: Beijing’s bid to rein in the country’s debt pile has hung over markets all year. Concern built during the congress that President Xi Jinping -- more powerful than ever after the twice-a-decade meeting -- will champion a ramping up of the deleveraging drive now that the event has passed. PBOC chief Zhou stoked this angst by reiterating his concerns about corporate debt risk during the congress.
- The China Factor: Individuals account for the majority of trading in China’s mainland equity market, which means slight changes in sentiment can lead to extreme moves as players follow the herd. Speculation officials would ensure stability during the congress -- as is typical around key political events -- merged into concern they would pull the rug once the meeting was over, compounding the recent selloff.
So, what’s next for China’s markets now the big political shindig is done and dusted and the “Xi Jinping put” has expired?
Here’s what analysts are looking out for:
Investors shouldn’t say goodbye to state-backed market stability just yet.
U.S. President Donald Trump is due to visit Beijing late next week and the trade deficit and China’s currency will almost definitely be on the agenda, says Ken Peng, an investment strategist at Citi Private Bank in Hong Kong. That means the yuan -- which is managed by the PBOC via a daily reference rate -- could strengthen, or at least remain stable, into the meeting, Peng said.
Chinese bonds and stocks could benefit too given Trump may want to unveil some deals and initiatives that bolster the links between Chinese and American business, according to Banny Lam, head of research at CEB International Investment Corp. in Hong Kong.
The Deleveraging Bugbear
This is probably the biggest factor Chinese assets will have to contend with in the medium term. Officials from PBOC boss Zhou down have signaled a determination to push ahead with the campaign to cut China’s debt risk. A front-page commentary published Thursday in the central bank-backed Financial News said that China should step up efforts to clean up its “financial mess.”
But China observers have differing views on how this will play out. While bond giant Pacific Investment Management Co. see policy makers taking a selective approach and refraining from broad-based deleveraging, China’s biggest brokerage -- Citic Securities Co. -- expects Beijing to implement a raft of measures by end-2017.
Huachuang Securities Co. is also in the latter camp, with analysts at the Guiyang-based firm saying China’s bond holders may be about to get hit by “daggers falling from the sky,” in a note last week.
Follow the Fed?
Whether the PBOC tracks the Federal Reserve in tightening monetary policy could be key.
Ming Ming, head of fixed-income research at Citic Securities, says it’s likely to -- by boosting the cost charged on open-market operations -- so as to insulate the yuan from declines into end-2017. That could boost 10-year yields to as high as 4 percent from the current 3.89 percent, says Qin Han, chief bond analyst at Guotai Junan Securities Co. in Shanghai.
Others aren’t so sure. Zhu Haibin, chief China economist at JPMorgan Chase & Co. doesn’t see China keeping pace, while Helen Qiao, chief Greater China economist at Bank of America Merrill Lynch, says the PBOC may boost funding costs in 2018, when it’s more apparent what’s happening with inflation.
China’s currency has been allowed to track a wilder path this year, a shift that has damped one-way bets on its depreciation -- for now. Some analysts see further flexibility in the yuan going forward, with Larry Hu, head of China economics at Macquarie Securities Ltd. in Hong Kong, predicting the PBOC could even start relaxing the capital controls put in place from the end of last year to stymie outflows.
China’s yuan policy will become “more like a sponge rather than a brick,” said Citi Private Bank’s Peng. Officials may ease curbs on Chinese residents’ investments overseas and limits on foreign companies’ profit repatriation, he said.
“Overall, the policy will be flexible rather than fixed.”
©2017 Bloomberg L.P.
With assistance from Tian Chen