BEIJING — China's central bank halted purchases of government bonds on Friday in an attempt to slow one-way bond trading that is putting unwelcome downward pressure on the yuan, analysts said.
The yield on China's 10-year bonds fell to a record low this month, and the Chinese currency in Hong Kong on Wednesday reached its weakest level against the US dollar in over a year.
The People's Bank of China is “trying to cool the market by pausing government bond purchases,” said Larry Hu, chief China economist at Macquarie.
The decision “suggests that the PBOC is concerned about the recent rapid decline in bond yields as this will increase CNY depreciation pressure now and SVB-style financial risks in the future,” Hu said, referring to a major U.S. bank failure in 2023 that will largely was largely blamed on changes in capital allocation as a result of the Federal Reserve's aggressive interest rate increases.
The PBOC it was announced before the market opened on Friday that this was the case by suspending the purchase of government bonds.
The PBOC's bond purchase program actually began only last year. PBOC Governor Mr. Gongsheng said in a high-profile speech in June that the central bank would implement it gradually add buying and selling government bonds on the secondary market to your monetary policy toolkit.
“The PBOC may be trying to signal to all market participants that interest rates have dropped too low, too fast,” said Peter Alexander, founder of Shanghai-based consulting firm Z-Ben Advisors. “Their departure should lead to a rate hike, at least in the short term.”
“The direct result was a slight increase in profitability. However, we expect this impact to be relatively short-lived if the PBOC merely holds back rather than defending a specific yield target as it did last year; “The factors causing the decline in bond yields, such as weak market confidence leading to high demand for safe sources of yield, persist,” said Lynn Song, chief economist at LNG.
Limiting stimulus
China is also struggling with slower economic growth at home. In late September, the country stepped up interest rate cuts and other forms of support following the U.S. Fed's move to easier monetary policy.
The decline in bond yields limited the extent to which the PBOC could further cut interest rates if it needed to further stimulate the economy, said Zong Ke, portfolio manager at Shanghai-based asset management firm Wequant.
He said the PBOC's sudden halt was also intended to warn investors against speculative buy-in to rising bonds, deepening the decline in yields.
The PBOC justified its decision by the shortage of bonds and announced it would resume purchases when the balance of supply and demand changes.
Capital outflows
Zhiwei Zhang, president and chief economist of Pinpoint Asset Management, noted that the gap between China and U.S. government bond yields has widened, putting pressure on the yuan exchange rate.
Compared with the US 10-year Treasury yield of 4.68%, the Chinese government 10-year bond yield is around 1.64%. This gap is even greater than in August, when concerns about the decline in China's profitability have intensified.
A stronger dollar and higher US Treasury yields make US-denominated assets relatively more attractive to international investors, which theoretically supports capital outflows. The dollar rose on expectations of continued U.S. economic resilience.
“The unusually high demand for bonds is likely also partly due to rising expectations for a large stimulus in 2025 to address weak consumption and fight deflationary pressures,” said Brian Tycangco, an analyst at Stansberry Research.
“Unfortunately, the suspension of bond purchases will reduce price transparency on the domestic bond market, making it somewhat more difficult for market participants to execute orders,” he said.
Following the PBOC's announcement, China's 10-year yield has changed little since Friday afternoon. Stock markets in mainland China and Hong Kong recorded slight declines.
Supporting the yuan
China has also recently stepped up efforts to support the yuan by issuing bills in the Hong Kong market. On January 15 in Hong Kong, the PBOC will auction six-month bills worth 60 billion yuan The Hong Kong Monetary Authority announced on Thursday.
Coupled with Friday's suspension of bond purchases, the Bank of China is seeking to use its toolkit to signal the yuan's stability and support a gradual decline in yields, said Zong Liang, chief analyst at Bank of China.
On Friday, the Chinese yuan in Hong Kong strengthened slightly.
Haizhong Chang, executive director of corporate affairs at Fitch Bohua, expects the PBOC's move will help bring long-term bond yields “back to a reasonable level and also help stabilize the RMB exchange rate.”
— CNBC's Anniek Bao and Ying Shan Lee contributed to this report.