China’s Battered Bonds May See Further Pressure on Funding Pains

Photographer: Qilai Shen/Bloomberg

Concern about tighter liquidity in China is reverberating through the nation’s financial markets. Government bonds are heading for a fourth month of declines, a rally in stocks has been slowed, while the yuan has strengthened to its highest level since January.

The yield on China’s sovereign bonds due in a decade climbed 10 basis points this month as of Friday to 3.08%, near the highest level since January, according to data compiled by Bloomberg. That followed a jump in the seven-day repurchase rate, an indicator for interbank borrowing costs, which have been hovering near a six-month high.

Worries about liquidity have been stoked by a cautious central bank that has refrained from cutting any interest rates and resorted to more expensive, longer-term policy loans to add cash. Conditions could get even tougher next month, as banks will be compelled to invest in 1.13 trillion yuan of government bonds and repay 960 billion yuan of policy loans.

“Banks will face even greater pressure next month, as the demand for cash will be stronger at quarter-end and Beijing continues to refrain from broad easing,” said Xing Zhaopeng, an economist at Australia and New Zealand Banking Group Ltd. “China’s government bonds will likely see a panic selloff in September as the money market sees wilder volatility.”

One winner from this scenario is the yuan. The currency has rallied for a third month versus the dollar to edge closer to this year’s peak, supported by the divergence in monetary policy in China and the U.S.

The picture for stocks is more mixed. The CSI 300 Index has risen 3.2% this month as of Friday, after surging 13% in July and almost 8% in June. While the economic recovery may help sustain gains, a flood of new share sales on Shenzhen’s ChiNext board following a change to initial public offering approvals will add to concern about liquidity.

— With assistance by Qingqi She, Shuqin Ding, and Amy Li