The rally on the bond market may be weakening temporarily. But China’s government still has to worry about the financial market stability of the world’s second-largest economy.
The Chinese central bank wants to use stress tests to check whether the People’s Republic’s banks and financial institutions can cope with major fluctuations in the government bond market. Chinese state media reported this this week.
The background to this is the ongoing concern of financial policymakers in the world’s second-largest economy for months that the volatility in the bond market could escalate into a liquidity crisis in the banking system and endanger China’s financial stability.
The leadership in Beijing has repeatedly expressed criticism of the extent of the bond purchases, which have pushed yields down sharply. The authorities want to use their tests to find out how banks react to a sudden rise in yields of double-digit basis points.
Bond trading collapses
Until early August, a pronounced rally in ten-year government bonds had led to record low yields. Recently, however, trading in these bonds collapsed after the Chinese government revised regulations, exerted pressure and even publicly criticized the banks.
Bloomberg had reported that Chinese regulators had instructed commercial banks in Jiangxi Province, for example, not to settle their purchases of government bonds. This has not been confirmed; the information policy in the isolated Chinese financial system is, as usual, poor.
On Monday, the central bank kept its key interest rate and reduced liquidity on the market – this is also likely to further cool the rally on the bond market. The prices of long-term government bonds fell to their lowest level in around a month at the start of the week.
However, according to experts, the movement in the market is not over: “Investors should prepare for volatility in China to increase further during the authorities’ stress tests,” said Zhaopeng Xing, investment strategist at the Australia & New Zealand Banking Group, according to Bloomberg.
Improved lending
Bond prices move inversely to yields. A recovery in yields provides financial leeway for Chinese insurance companies, for example, which have invested heavily in the bond market.
Experts believe that the Chinese central bank also wants to encourage financial institutions to lend to the real economy instead of parking money in bonds. Lending in the country has recently been declining. The Chinese economy is currently struggling with slower growth and overall weaker economic momentum.
Insurance companies have pumped large sums into the Chinese bond market because there is currently a lack of attractive investment opportunities in China.
This is partly due to the collapse of the real estate market, which had contributed around 25 percent to China’s economic output before the crisis. On the other hand, the stock market has been in crisis for several years and is only recovering with difficulty from its lows. In addition, the economic outlook has continued to deteriorate. As a result, gold is almost the only possible investment, along with government bonds.
The Chinese central bank is – unusually for the authoritarian political system of the People’s Republic – making an effort to explain some of its steps publicly. Central bank governor Pan Gongsheng said in an interview with state broadcaster CCTV at the weekend that the People’s Republic wants to “stick to a supportive monetary policy, promote credit growth and gradually reduce financing costs.” Such public statements are intended to strengthen confidence in China’s financial stability.