(Bloomberg) -- A popular Treasuries trade is being replicated in China, where the gap between long and short-dated yields is widening as the central bank pushes to better control the bond market and signal a healthier economy.
The gap between two- and 10-year yields has hit levels last seen in 2020, while that between five- and 30-year equivalents is at its steepest in about a year. But analysts are divided on whether so-called steepener bets will reach critical mass.
While market participants have some faith in the People’s Bank of China bringing short-term yields lower, they are skeptical of its ability to guide long-dated ones higher as a deepening pessimism toward the world’s second-largest economy acts as a countervailing force.
“Front-end bonds are more sensitive to monetary policy moves and liquidity conditions while back-end bonds reflects more to growth and inflation expectations,” said Tiffany Wang an emerging-markets strategist at JPMorgan Chase & Co. in Hong Kong. “So I would say with the policy rate cut, it can still steepen a little bit, but we’re probably going to be nowhere near the previous kind of extremes.”
The PBOC is juggling a number of differing goals, all of which can impact the shape of China’s yield curve. It’s lowered interest rates to boost the economy and is tightening its grip on them, setting up the seven-day repurchase rate to be the new benchmark. At the same time, it’s trying to cool a rally in longer-dated bonds by warning it will borrow and sell them if the market doesn’t self-correct.
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PBOC Governor Pan Gongsheng and his predecessor Yi Gang have both spoken about their desire to maintain a “normal, upward sloping” yield curve in public speeches in recent years. This provide incentives for the market to invest, Pan said in June.
On the contrary, a flattening yield curve is usually seen as a bearish signal over a country’s longer-term growth prospects. And with the yields of China’s benchmark bonds not far off a record low, that’s a legitimate concern.
“I think their intention is sort of to have a modestly upward sloping yield curve,” said Andrew Tilton, chief Asia-Pacific economist at Goldman Sachs. “The reality though is that in any major housing downturn, you see yields go down basically around the world. To some extent, they’re fighting what is the natural path of rates.”
In the US, curve-steepener strategies have gained in popularity with the Federal Reserve expected to start rate cuts this year, just as concerns grow about the country’s debt dynamics, which have the potential to push up longer-dated yields.
Front-End Flurry
China traders flocked to buy short-dated government bonds after the PBOC’s surprise cut to the seven-day reverse repo rate on Monday with the sector seeing the biggest net buying interest on MarketAxess, an electronic trading platform used mainly by offshore investors. Last week, volumes at the short-end hit a daily record three times for the platform, according to Roheet Shah, the company’s head of dealer sales for APAC.
For Lemon Zhang, an FX strategist at Barclays Bank in Singapore, the front-end of the curve will be volatile given the PBOC’s actions and market positioning. And while more bond issuance could lift longer-dated yields, she only expects a gradual steepening of the curve.
“We are skeptical about the PBOC’s ability to guide yields much higher over time,” she wrote in a note this month. “Bond operations could put a floor under yields in the short run, but longer-term macro fundamentals need to improve significantly to sustain any upmove in yields.”
JPMorgan’s Wang follows the gap between one- and 10-year yields, which has widened to about 76 basis points, the steepest since August.
“There will be some room for the curve to steepen,” she said. “I would say probably another like 10 basis points or 15 basis points, not too much beyond that.”
--With assistance from Yujing Liu.
©2024 Bloomberg L.P.
