China's Bond Market: The Rocky Road Ahead

China's central bank-backed media Financial News warned of risks in price fluctuation as a rally in Chinese sovereign bonds continued. Despite PBOC's warnings, yields on 30-year bonds have dropped significantly. With a sputtering economic recovery and new bond issuance, investors are overlooking negative factors affecting the debt market.

China's central bank-backed media Financial News warned on Friday of price fluctuation risks in bonds as a rally in Chinese sovereign bonds extended, saying investors overlooked negative factors weighing on the debt. The People's Bank of China (PBOC), which has pledged to add treasury bond trading to its monetary policy toolkit, has issued repeated warnings against plummeting yields in long-dated government bonds, but has failed to reverse the trend.

Pressure is growing on the PBOC to back statements with action - meaning it would be forced to end a 17-year absence from the bond market by selling. A sputtering recovery in the world's second-biggest economy has driven the record-breaking rally in Chinese government bonds over the past few months, with yields on 30-year bonds down as much as 40 bps this year.

"There are many negative factors currently, but they have been ignored by investors intentionally or unintentionally," the PBOC-backed Financial News said in an editorial on Friday, citing financial industry sources. "From a fundamental perspective, with the recovery of inflation and other indicators, investors' expectations for the economic situation are gradually recovering," it wrote.

The paper also said the acceleration in bond issuance since late May will "change the supply and demand pattern of the bond market", as investors faced 'asset famine' due to slower-than-expected long-term bonds issuance. China's finance ministry auctioned 50-year bonds at a yield of 2.53% on Friday, a record low for paper with such tenor and below market expectations, highlighting investors' strong demand for safe-haven assets.

China's central bank is widely expected to leave a key policy rate unchanged when rolling over maturing medium-term loans next Monday, a Reuters survey showed, as worsening interest margins and a weakening Chinese yuan continued to hobble authorities' monetary easing efforts.