A tremor in China’s bonds

In 2015, a Chinese stockmarket slump rattled global investors. But Chinese bonds are “far more important”, says Pete Sweeney on Breakingviews. And it may be “time to start worrying” about them. The key trend in the $9trn fixed-income market recently has been a jump in the ten-year government bond yield, reflecting falling prices. The yield has edged above 4% for the first time in three years.

Corporate debt is priced off state debt, so this implies higher borrowing costs for China’s highly indebted companies. The average yield on five-year, triple-A-rated corporate paper, a key gauge of company funding costs, has hit 5.2%, also a three-year high, notes Shen Hong in The Wall Street Journal. Corporate debt accounts for most of the country’s huge overall debt pile, worth 269% of GDP now, up from 149% in 2007. The Chinese central bank recently warned of a “Minsky moment” – a sudden slide in asset prices following excessive speculation and borrowing. The worry is that a jump in corporate borrowing costs could be the pin that pricks the Chinese bubble.

It may be too soon to panic, however. As Shen Hong points out, growth has slowed a bit of late, which should imply more demand for government bonds, and corporate lending still looks healthy. “The volume of loans going to corporates is still pretty large,” according to Chen Kang of CreditQuant Asset Management. The key cause of the recent rise in bond yields has been a government clampdown on speculation and leverage. Regulators have put paid to practices they felt were being abused, such as borrowing for short periods using bond-repurchase agreements. 

More broadly, however, the bond-market tremors are a reminder of how difficult it will be to maintain economic stability and reduce systemic leverage at the same time – not least because the financial system is “increasingly intertwined”, as Anjani Trivedi says in The Wall Street Journal. The latest rise in borrowing costs for small and medium-sized banks, a result of the state’s anti-speculation drive, has prompted them to put more of their money in the non-bank, or “shadow banking” sector, where trust companies and funds offer higher returns.

But the overall amount of money going from banks into the shadow sector has fallen as interest rates have risen. Faced with redemptions, the shadow system has sold some liquid investments such as government bonds to compensate. This kind of knock-on effect could prove hard to contain in a major sell-off. Achieving a soft landing will not be easy.