China’s government bonds tumble after US Fed’s hawkish inflation outlook

Benchmark 5-year and 10-year bond futures plunged by their daily allowable limit for the first time on record

PUBLISHED : Thursday, 15 December, 2016, 12:11pm
UPDATED : Tuesday, 03 July, 2018, 9:47pm

China’s bond market saw a record sell-off on Thursday, unnerved after the US Federal Reserve foreshadowed a faster-than-expected pace of interest rate increases in 2017.

Benchmark 10-year treasury futures for March delivery closed 1.81 per cent lower, the biggest drop since they resumed trading three years ago. They were down as much as 2 per cent intraday, the maximum change allowed.

Five-year treasury futures for March delivery ended 1.16 per cent lower, after tumbling to their permissible daily floor of 1.2 per cent in morning trading.

It is the first time that Chinese government bond prices have dropped to their allowable daily floor price since the financial derivatives market was resumed three years ago.

The benchmark 10-year government bond yield jumped to 3.39 per cent, compared to the intraday high of 3.2 per cent the previous day. Bond price moves inversely to yield.

With long-term yield rising, the short-term borrowing cost in the money markets is also jumping.

The Shanghai Interbank Offered Rate, or Shibor, headed higher across the board for the third straight day. The three-month Shibor rose for 41 days consecutively to 3.1635 per cent, while overnight Shibor rose 1.1 per cent to 2.311 per cent.

Turmoil in the bond market prompted the People’s Bank of China to inject a net 145 billion yuan through its open market operations to stabilise the market.

Meanwhile, the central bank reportedly called major Chinese banks after the sell-off, asking them to release long-term liquidity to non-banking financial institutions, Reuters reports.

The record sell-off came after the US Fed increased its key interest rate by 0.25 per cent overnight, the second such move in a decade, signalling the end of an era of easy capital.

Fed officials raised their target for short-term interest rates by 0.25 percentage points to a range of 0.50 per cent and 0.75 per cent.

Watch: US Fed increases interest rate by 25 basis points

While the rate increase was within market expectations, the Fed also gave guidance for three rate rises in 2017, up from the two increases that were projected at its September meeting before Donald Trump was elected as the incoming US president.

Boosted by the hawkish statement from the Fed, the yield on US benchmark 10-year Treasury notes rose to 2.5986 per cent as of 4.47pm Hong Kong time , compared with 2.446 per cent right before the Fed’s rate statement.

“The plunge is not only because of the Fed’s rate decision, but also due to the PBOC’s recent moves to withdraw liquidity from the market as well as the speculation of default cases in China’s bond market and money market,” said Shen Jianguang, chief Asia economist at Mizuho Securities in Hong Kong.

“The tumble highlights the end of a bull run in the bond market and a long-term upward trend for bond yields, given the surging US bond yields and increasing inflation. The 10-year government bond yield could reach 3.5 per cent in 2017.”

Some traders said the panic in the market has been overblown, because onshore traders are protected by the country’s closed capital account.

“The monetary policies in China and the US are divergent,” said China Merchants Bank’s analyst Liu Dongliang. “It’s hard to imagine that China will start a cycle of monetary tightening before it accomplishes reforms and the economy hits the bottom. It is not the start of a bear bond market in China.”

With reporting by Wendy Wu in Beijing.