BEIJING: China’s central bank is readying a bold new experiment in global monetary policy – taking a leaf out of the hedge fund playbook and arranging to short sell bonds.
As President Xi Jinping and his top Party colleagues prepared for this week’s once-in-five-year Third Plenum to chart the broad economic path ahead, governor Pan Gongsheng’s People’s Bank of China (PBoC) has been busy lining up “hundred of billions” of government bonds it could sell to prevent a bubble forming in the nation’s US$4 trillion debt market.
Having long eschewed quantitative easing, the PBoC is now set to embrace the unorthodox policy of steering yields by dealing directly in the bond market, but from an unusual direction.
Where the Federal Reserve and peers bought bonds to push yields down when their economies flat lined, the PBoC is readying to sell them to guide long-term yields higher as a rally extends to record levels.
It’s a policy experiment stemming from the complex and conflicting challenges confronting Pan.
Mired in a property slump and beset by deflation, China’s economy clearly needs a low interest-rate environment; but not so low that it hurts bank profits, leads to a debt binge or weakens the yuan at a time of US dollar supremacy.
“With the ultimate goal of engineering a soft landing, this process is becoming more and more difficult to manage,” said Torsten Slok, chief economist at Apollo Global Management in New York.
“There are so many moving parts that need to slow down gradually.”
The PBoC didn’t immediately respond to a request for comment.
Compounding the problem, China’s slowdown has created a dearth of viable investment choices for its hundreds of millions of savers – outside of traditional haven bonds.
Home prices are falling, stocks are in a funk and regulators are tightening the screws on risky alternatives.
“The equity market’s a disaster, credit is risky, real estate: Forget it. Foreign investments, well that’s curtailed and also has its own risks.” says 37-year market veteran Rajeev De Mello, a portfolio manager at GAMA Asset Management SA in Geneva.
“It’s a real worry.”
For one thing, falling yields are reinforcing speculation the PBoC will need to guide official interest rates lower, something it’s reluctant to do for fear of weakening the yuan further.
China’s objective is the desire for a “powerful currency” that helps solidify the country as a major financial power.
And while low yields support growth by lowering borrowing costs for everything from corporate debt to residential mortgages, a protracted period of them just reinforces concerns about the Japan-ification of the Chinese economy.
Perhaps most worryingly for the PBoC, the surge in bond buying at low yields could lead to massive losses in China’s bank-heavy economy if inflation were to rekindle and yields were to spike higher. Some investors borrow to buy bonds, putting them at risk of a funding crunch if there’s a mismatch between short- and long-term yields.
Silicon Valley Bank’s collapse showed central banks around the world that they should monitor and prevent risks accumulating in the financial market, Pan said at the Lujiazui Forum last month.
Official warning shots since late April have largely fallen on deaf ears.
Instead, investors keep chasing the momentum, sceptical about prospects for any near-term turnaround in the economy.
“The market is gaming with the PBoC,” and is probably right, said Chen Kang, vice- president at Shanghai Tianzeng Private Fund Management Co Ltd.
“Past market reversals were usually prompted by the economy improving, credit risks and tightening monetary policy. These things are unlikely to occur in the short term.”
Mary Nicola, strategist for Markets Live in Singapore, said: “Without significant structural reforms to foster consumption-led growth and manage the demographic transition, China is likely to follow in Japan’s footsteps. Sustained low yields and sluggish economic performance will become the new norm. — Bloomberg
