Livia Yap and Tian Chen

July 8, 2021

  •  Benchmark 10-year bond yield falls below key 3% level
  •  China State Council raises possibility of RRR cut for support

China’s government bonds rallied, sending the benchmark 10-year yield to the lowest level since August, after the government indicated that the central bank could loosen its policy to support the economy.

The yield on the most actively traded 10-year sovereign notes tumbled six basis points to 2.99%, while futures contracts of the same tenor jumped by the most in over a year. A gauge of trader expectations for borrowing costs in the future slid to the lowest level since January.

The move came after the State Council hinted that the People’s Bank of China could make more cash available to banks in order to boost lending to businesses, including by cutting the amount of money they have to hold in reserve. A potential easing could provide the bond market with much-needed liquidity to absorb the flood of local government debt sales as a swathe of policy loans mature in the second half of the year.

“This is an important dovish shift and is likely to drive unwind of residual policy normalization fear and expectations, and render some support to broad risk assets,” Citigroup Inc. strategists led by Gaurav Garg wrote in a note. The yield on China’s 10-year government bonds could fall to 2.90% to 2.95% as a result, they added.

China's 10-year yield drops to 11-month low on easing bets

After leading the way in weaning its economy off stimulus, China is showing its willingness to support businesses as the recovery begins to slow. The potential move would be in stark contrast to other major central banks that are looking to unwind some easing measures as their economies recover from the pandemic-driven slump.

A broad step toward policy easing would also be a shift from China’s recent focus on doing just the minimum to cater for short-term and one-year cash needs. The PBOC has added just 10 billion yuan ($1.5 billion) into the banking system via open market operations each day since March, apart from five sessions in June when interbank funding costs surged ahead of the quarter end.

Strategists from UBS Group AG and Australia & New Zealand Banking Group Ltd. are forecasting a reserve ratio cut for China’s banks in the coming weeks to offset some of the 4.15 trillion yuan of the medium-term lending facilities coming due by the end of the year.

China’s bond rally kicked off on Wednesday after a former central bank official called for a rate cut in the second half. The 10-year bond futures posted what was this year’s biggest intraday jump. Open interest in the derivatives — a measure of outstanding positions — rose to a record 167,000 contracts, signaling that traders are making net long bets on lower yields.

Yuan Sheltered

The impact of a likely easing on the yuan is expected to be limited.

“Policy divergence of the Fed and the PBoC could narrow yield differentials and chip away the carry advantage of the renminbi,” said Fiona Lim, senior currency strategist at Malayan Banking Berhad. “However, the potential support of such a monetary policy action for the real economy and domestic assets may mitigate the impact on the renminbi.”

The yuan and Chinese stocks fell alongside emerging Asia peers amid risk-off sentiment on Thursday. The yuan declined 0.1% to 6.4793 per dollar while the CSI 300 Index dropped as much as 1%.