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China has adopted an unusual tactic to discourage banks from buying government bonds, as authorities try to halt an uncomfortable decline in yields and prevent a bubble forming: naming and shaming the buyers.
China’s interbank regulatory body this week announced an investigation into four rural commercial banks for “manipulating sovereign bond prices in the secondary market”.
The probe is widely seen as a reprimand to smaller regional lenders who snapped up government debt after larger state banks unexpectedly began selling.
It comes as the battle between Chinese authorities and the country’s bond investors intensifies this week. Ten-year sovereign bond yields, which move inversely to prices, fell to record lows on Monday in a sign that markets are increasingly concerned about low growth and deflationary forces in the economy.
While buying of their sovereign bonds may be welcomed by many countries, the People’s Bank of China has repeatedly warned that a bubble is forming in the sovereign bond market, with regulators saying that regional banks’ appetite for long-term government debt risks triggering a Silicon Valley Bank-style crisis if there is a sudden surge in yields.
“The local PBoC branch called us and advised us not to buy bonds when state lenders are selling,” one bond trader at a local lender in Jiangsu province said this week.
“They blamed a few rural banks in Suzhou for acquiring bonds sold by the state banks.” On Monday, large banks sold a net Rmb22bn of long-dated bonds, 10 times the daily average last week, according to BNP Paribas’ securities market data.
The government is also trying to spur economic growth by pushing regional lenders away from parking their money in ultra-safe bonds and instead lending it out.
Benchmark 10-year yields have picked up slightly from their all-time low of 2.12 per cent earlier this week, rising to 2.15 per cent on Thursday.
The moves come after the National Association of Financial Market Institutional Investors (NAFMII) on Wednesday said some smaller lenders “have engaged in irregularities”. In a separate announcement, NAFMII said it was launching an investigation into Jiangsu Changshu Rural Commercial Bank, Jiangsu Suzhou Rural Commercial Bank, Jiangsu Jiangnan Rural Commercial Bank and Jiangsu Kunshan Rural Commercial Bank for potential market manipulation of sovereign bonds.
Analysts said it is rare for NAFMII to publicly address trading of sovereign bonds, suggesting it indicated that more restrictions may follow.
“Some policymakers appear to view low long-term [government bond] yields as a sign of low expectations for domestic growth and inflation expectations, and would like to push back against this pessimistic sentiment,” said Goldman Sachs analysts in a recent note to clients.
In July, the PBoC struck a deal with Chinese financial institutions that allows it to borrow several hundred billion renminbi of long-dated bonds and sell into the market. But there is little evidence yet that the central bank has used this new tool to fight the bond rally, which has been driven by investors’ hunger for haven assets in a weakened economy mired in a prolonged property crisis.
The country’s manufacturing activity fell for a third consecutive month in July, while its export growth missed expectations last month in dollar terms.
Instead, authorities have responded with a fresh raft of warnings and new market interventions this week.
The moderate increase in yields follows significant sales of seven to ten-year notes by state banks, including the Industrial and Commercial Bank of China and Bank of China, according to bond traders from mid-sized city commercial banks.
In another move, the fund industry regulator slowed down the approval of new funds tracking long-term sovereign bonds with maturities over two years, in a bid to curb flows into government debt.
“This only applies to newly established funds,” said a Beijing-based bond fund manager at a leading mutual fund house. “There are still significant inflows into the sovereign bond market from existing bond funds.”
China in May began to sell Rmb1tn ($140bn) of long-dated bonds in order to fund its long-term economic transition.