China's Central Bank Warns of Potential Reversal in Long-Term Government Bond Rally

The People's Bank of China (PBOC) has issued a warning about the recent rally in China's long-term government bonds, suggesting a potential reversal due to a mismatch between market prices and the economic outlook. An official from the PBOC expressed optimism about China's long-term growth but noted that current yields do not align with this outlook, attributing the discrepancy to temporary supply and demand factors.

The PBOC's cautionary stance led to a significant selloff in government bonds, with futures on China's 30-year debt experiencing a record loss since their debut. The China Government Bond Curve has bear-steepened, with yields 2-5 basis points higher across benchmarks following the comments from the PBOC official.

The central bank official highlighted the risks associated with long-duration bond positions, especially those that are leveraged, and advised banks and insurers against locking in funds into long-duration bonds at low yield levels. The PBOC also clarified that its bond buying and selling activities are distinct from quantitative easing operations seen in other countries, aligning with President Xi Jinping's remarks on gradually increasing government bond trading in open-market operations to support the economy.

Why this matters: The PBOC's warning signals a potential shift in China's bond market dynamics and could have implications for investors and financial institutions holding long-term government bonds. The central bank's stance also highlights the delicate balance between supporting economic growth and maintaining financial stability.

Analysts expect the PBOC to start bond trades in the secondary market from May to fulfill liquidity demand, while also expecting bond supply to increase and yields on long-dated bonds to rise further. The PBOC official cited the case of SVB Financial Group as a lesson, warning investors to be highly aware of interest rate risks, particularly those holding heavy long-duration bond positions.

Key Takeaways

• PBOC warns of risks in China's long-term govt bond rally, citing mismatch with economic outlook.
• PBOC bond buying/selling distinct from QE, aims to support economy through open-market operations.
• PBOC expects bond supply to increase, yields on long-dated bonds to rise further.
• PBOC warns investors of interest rate risks, especially for those holding heavy long-duration bonds.
• Analysts expect PBOC to start bond trades in secondary market from May to meet liquidity demand.