China’s central bank has signaled its discomfort with the recent bond market rally, which has seen sovereign bond prices surge to record levels. The People’s Bank of China (PBOC) issued a warning on Wednesday, urging financial institutions involved in “aggressive trading” to be cautious of the risks, including those related to interest rates. This warning prompted a slide in the market, with yields climbing after falling to record lows earlier in the week.
According to reports from PBOC-backed Financial News, the central bank’s warning marks its first significant statement in months regarding the bond market’s rapid rise.
Bond Yields Climb After Record Lows
Following the PBOC’s caution, yields on China’s benchmark 10-year government bond rose as much as four basis points to 1.77%, before easing slightly to a gain of one basis point. Earlier in the week, yields had fallen to an all-time low. Similarly, futures contracts on 30-year bonds dropped by as much as 1.8% before recovering to a loss of 0.6%, marking the largest decline since September.
The rise in yields follows a period of rapid bond buying by investors betting that increasing U.S.-China trade tensions would prompt the Chinese government to introduce stronger monetary stimulus to support economic growth next year. The sharp drop in yields had raised concerns that China could be heading into a Japanese-style balance sheet recession.
Concerns Over Economic Recovery and Policy Risks
Analysts have noted that the recent bond market activity was driven by fears of a potential trade war with the U.S. and a sluggish recovery in China’s economy. The widening yield differential between China and the U.S. has also weighed on the yuan, further increasing concerns.
Ju Wang, Head of Greater China FX & Rates Strategy at BNP Paribas, commented that while the market may expect a 40-50 basis point rate cut next year, the PBOC likely views the rapid bond market movements as “too fast, too quick.” He emphasized that while the market might continue betting on further stimulus, the regulators are wary of excessive speculation in the bond market.
Efforts to Slow the Frenzy
Earlier this year, the PBOC had already issued verbal warnings to slow down the buying frenzy in the sovereign bond market. The central bank also conducted regulatory checks with bond investors and sold long-term bonds to curb speculation. However, a slow and uneven economic recovery and disappointing growth support measures have kept downward pressure on yields.
Kiyong Seong, a macro strategist at Societe Generale in Hong Kong, believes that the PBOC’s warning could be an excuse for investors to take profits after the relentless rally in Chinese bonds. Still, he doubts the warning will significantly change the market trend. Seong predicts that China’s 10-year bond yield could rise to 2% in the first quarter of 2025.
Future Outlook for Chinese Bonds
Some analysts, including those from Tianfeng Securities, Zheshang Securities, and Standard Chartered Bank, had previously predicted that yields could drop even further, to 1.5%-1.6% by the end of 2025. However, with the PBOC’s warning now in place, the future trajectory remains uncertain.
The central bank’s recent actions echo concerns over “one-way” buying in the bond market, similar to the situation in the U.S. following the 2023 collapse of Silicon Valley Bank, which had heavily invested in U.S. Treasuries before the market reversal. The PBOC is likely hoping to avoid a similar scenario in China by preventing excessive long bond positions and mitigating risks associated with a sharp market reversal.
As the situation develops, investors will be closely monitoring the central bank’s next moves and economic indicators to gauge the future direction of China’s bond market.
