A month ago, China 5s10s curve inverted for the first time ever, flashing warning signs of an imminent recession (but technical, liquidity factors were offered as excuses for this shift in the belly of the curve). The curve then double-inverted (with 3s10s inverting) seemingly confirming fundamental fears. And now, China's yield curve is inverted from 1Y to 10Y for the second time in history.
# China's $1.7 trillion government-bond market is turning curiouser and curiouser...
The yield on China’s one-year government bond climbs 6 basis points to 3.66%, rising above the 10-year yield of 3.65%, ChinaBond data show...
This is only the second time that the yield curve has inverted in data going back to 2006, with the first coming during a record cash crunch in June 2013.
As The Wall Street Journal recently wrote, such a “yield-curve inversion” defies normal market logic that bonds requiring a longer commitment should compensate investors with a higher return. It usually reflects investor pessimism about a country’s long-term growth and inflation prospects.
# Perplexed traders and analysts offered up many excuses.
“Many of us are scratching our heads for an explanation because this kind of curve inversion is absolutely not normal,” said Wang Ming, a partner at Shanghai Yaozhi Asset Management Co, a bond fund that manages 2 billion yuan ($289.66 million) in assets.
“The inversion is a form of mispricing in the bond market,” said Liu Dongliang, senior analyst at China Merchants Bank . “The fact that no one is taking the bargain despite the higher yield on the five-year bond just shows how depressed investors’ mood is. It’s really difficult to predict when the selloff or such anomalies will end because China’s bond market is reacting to the regulatory crackdown only and is no longer reflecting economic fundamentals,” said China Merchants Bank’s Mr. Liu.
But of course, the reality is, without massive and continued credit creation, there are very large questions about just how 'dynamic' Chinese growth could be and while technical flows are certainly part of the reasoning for short-end yields rising, the question is, why wouldn't the rest of the world pile in to 'reach for yield'... unless the fundamentals really did have them worried?
The nature of the inversion (higher yields, higher funding costs, and leverage pressure) is starting to reflexively impact the real economy (and hence the chances of dramatically lower growth/recession), as The FT reports Chinese corporate bond financing hit a record low in May, as a market rout discouraged new issuance while a wave of previously issued notes came due...
The combination of tight liquidity and a regulatory crackdown on leveraged investment in bonds has hammered China’s debt market in recent months.
Net corporate bond financing, new issuances less maturities, totalled negative Rmb217bn ($31bn) in May, well below the previous record low of negative Rmb89bn in February, according to data from Wind Information.
A “regulatory windstorm” led by China’s ambitious new banking regulator, Guo Shuqing, has targeted banks’ use of borrowed money to invest in bonds.
The People’s Bank of China has also drained liquidity from the money market, making it more expensive for banks to borrow from each other to fund bond purchases.
“Banks’ demand for bonds has drastically reduced. The shock has been pretty large,” said Xu Hanfei, chief fixed-income analyst at China Merchants Securities in Shanghai. “Pressure has spread from the liabilities side to the asset side,” he said, referring to the impact of higher funding costs on demand for bonds.
“In the context of the increasing financing difficulty for bonds and non-standard (shadow bank) products, issuers of low quality are more severely impacted, and the corresponding credit risks tend to increase,” Haitong chief economist at Jiang Chao wrote this week.
# Investors are also nervous about rising credit risk.
According to a survey of investors by Haitong Securities, only 5 per cent of bond investors are “optimistic” about low-rated corporate bonds. Companies cancelled or postponed 400 planned bond sales worth Rmb390bnbn in the year to May, up from Rmb286bn in cancellations a year earlier, according to Wind data.
But apart from that, we are sure everything is fine in the world's biggest/second-biggest economy....