China Bond Traders Reckon With Central Bank That Won’t Budge

(Bloomberg) -- China’s central bank has helped trigger a massive sell-off in government debt by doing nothing at all.

The People’s Bank of China disappointed bond traders by skipping open-market operations every day this week -- effectively withdrawing 560 billion yuan ($79 billion) from the financial system. It has also wrong-footed bond bulls by not deploying a one-year targeted lending tool, despite the move being widely expected since last week.

Beijing’s message to markets on stimulus is no different to the calibrated approach it has stuck to all year. But the inaction this week stands out when most of the world’s central banks are easing, with the Federal Reserve cutting rates Wednesday for a third time this year. Throw in China’s surging inflation and the looming wall of supply from local authorities -- the result is the worst rout in sovereign bonds since April.

“The PBOC has refrained from flooding the market with cash partly because it remains wary of risks from a high debt buildup and the country’s still bubbly property market,” said Zhu Chaoping, a Shanghai-based economist at JPMorgan Asset Management. “This has limited the room for further monetary easing.”

Concern that additional cash injections won’t necessarily direct money into the real economy is keeping policy makers cautious, said Nathan Chow, an economist at DBS Bank Hong Kong Ltd. Beijing won’t want to flood markets with cheap funds and risk inflating a bubble in the property market -- or increase leverage in the financial industry.

“China needs to unclog monetary policy transmission,” Chow said.

The spread between 10-year Chinese and U.S. government debt is nearing the widest in almost two years. That gap makes yuan-denominated assets more attractive for international investors, which could cushion its tightly-managed but fragile currency.

China has chosen not to follow the Fed on its latest easing path, relying instead on tools such as its daily liquidity operations and banks’ reserve requirements to free up funds. It introduced a new loan prime rate in August as part of its interest-rate overhaul aimed at lowering borrowing costs. But it has yet to pull the trigger on the official lending rate.

Investors may get fresh clues on policy after the Chinese Communist Party concludes its key four-day meeting, where officials are expected to discuss the country’s next five-year economic blueprint. Data Thursday showed the outlook for China’s manufacturing sector worsened in October.

But for now, the risk is that China’s bond market will keep tumbling as traders price in the reality of limited liquidity injections. The 10-year yield slipped Thursday after touching a five-month high this week.

“Traders are now rushing to sell government bonds and stop losses,” said David Qu, an economist at Bloomberg Economics. “We may see more buying when the 10-year yield is close to 3.4%.”

--With assistance from Claire Che and Tian Chen.

To contact the reporter on this story: Hong Shen in Singapore at hshen87@bloomberg.net

To contact the editors responsible for this story: Richard Frost at rfrost4@bloomberg.net, Sofia Horta e Costa

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