Why China’s central bank is the ‘reliable boyfriend’ bond markets need
- Bond investors have faced a flurry of confusing and sometimes misleading messages from Western central banks, creating a disconnect in expectations
- In contrast, China’s central bank has been a paragon of restraint as it pursues financial stability above all other goals
The disconnect is most apparent in Britain, where the Bank of England’s decision last week not to raise rates despite having strongly hinted that they could rise this year stunned investors.
The move sparked criticism that Britain’s central bank was once again behaving like an “unreliable boyfriend”. It was the same accusation levelled at it in 2014 when it flirted with – and then rejected – higher borrowing costs.
Other central banks, notably those in Australia and Canada, have also confounded investors. Their decisions are fuelling uncertainty about the severity of the threat posed by higher inflation and causing intense volatility in short-term government bonds.
However, one central bank has proved adept at guiding market expectations. The People’s Bank of China (PBOC) has emerged as a bastion of stability and predictability amid the confusion over the conduct of monetary policy in Western economies.
In bond markets, the PBOC’s message of stability and restraint has come through loud and clear. In a report published on November 4, JPMorgan noted that markets are pricing in a trivial 22-basis-point rise in the benchmark one-year loan prime rate by the end of next year. The consensus among economists is that the main rate will remain unchanged.
From an Asian perspective, the PBOC looks positively dovish. Markets anticipate proper rate-increasing cycles in India, South Korea and Malaysia, with benchmark rates expected to increase 174, 138 and 105 basis points respectively by the end of 2022.
Yet, other factors are more important in explaining why the PBOC is successful at managing market expectations.
Second, while the dramatic sell-off in China’s “junk” bonds has damaged sentiment, the combination of surging foreign inflows into the country’s government debt market and a huge trade surplus is boosting banks’ holdings of foreign currency. This makes China less vulnerable to a global shock, reducing pressure on the PBOC to ease policy more aggressively.
Although its policy stance might be overly restrictive, it cannot be accused of overcommunicating, arguably the biggest problem facing Western central banks right now. There have been no big surprises in Chinese monetary policy of late and bond investors do not anticipate a major policy error, partly because of the tools at the PBOC’s disposal to provide sufficient liquidity.
The credibility of central banks is being sorely tested. Given the severity of China’s slowdown, the PBOC is bound to come under pressure to provide more stimulus. That bond markets are not expecting a major shift in policy should make its job easier.
Nicholas Spiro is a partner at Lauressa Advisory