China’s Bond Yields Throw Another Curve as Inversion Deteriorates

SHANGHAI –  A stubborn anomaly in China’s $1.7 trillion government-bond market has worsened, as an odd combination of tight funding conditions and economic pessimism pushed long-dated yields well below returns on one-year bonds, the shortest-dated government debt.

In the latest sign of stress in a market pressured by Beijing’s effort to clean up a debt-laden financial system and weak economic prospects, the yield on 10-year bonds fell to 3.55% on Tuesday, compared with the one-year paper’s 3.61%, a situation unseen since June 2013, when an unprecedented cash crunch jolted Chinese markets and nearly brought the nation’s financial system to its knees.

The so-called yield-curve inversion first surfaced a month ago, when the yield on less actively traded five-year bonds broke above that on the popular 10-year bonds. Bond yields move inversely to their prices.
The anomaly deteriorated two weeks later and took on a rare, new form: the yield on the illiquid seven-year bonds rose above those on both the five-year and 10-year paper, squeezing the curve into a shape that resembles a triangle.

An inverted yield curve defies common understanding 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.

When the U.S. Treasury yield curve inverted in 2006 and 2007, most analysts cited Asian central banks’ heavy buying of longer-dated U.S. government debt.

“But the curve inversion we are seeing right now is one with Chinese characteristics and it’s different from the previous one in the U.S.,” said Deng Haiqing, chief economist at JZ Securities.

The current anomaly in the Chinese bond market is partly the result of mild inflation and expectations of a slowing economy, Mr. Deng said. “At the same time, short-term interest rates will likely stay elevated because the authorities will keep borrowing costs high so as to facilitate the deleveraging campaign,” he said.

Since last summer, Beijing has embarked on a campaign to reduce long-term financial risk caused by reckless lending behavior among banks and leveraged investing that has created one asset bubble after another.

The effort intensified in February and March when the People’s Bank of China raised a suite of key money-market interest rates, which has since pushed up yields across the bond curve, especially those on short-dated tenors.
As a result, the one-year bond yield rose to a 31-month high of 3.66% on Thursday, while the increase in the yield on 10-year bonds has lagged behind.

In fact, the 10-year yield has fallen more quickly than its short-dated counterpart since Monday, when a brief, largely speculative rebound in bond prices emerged after Beijing sent somewhat soothing messages on its deleveraging campaign, analysts say.

In an article published Saturday, the central bank’s flagship newspaper, Financial News, said that the severe credit crunch four years ago won’t repeat itself this month because the central bank will keep liquidity conditions “not too loose but also not too tight.”

Chinese financial markets tend to be particularly jittery come June due to a seasonal surge of cash demand arising from corporate-tax payments and banks’ need to meet regulatory requirements on capital.

On Sunday, the official Xinhua News Agency ran a similar commentary that sought to stabilize market expectations. “Don’t panic,” it urged investors.

“The authorities’ soothing rhetoric certainly helped drive down yields and I think even if the curve inversion disappears one day, the curve will look pretty flat for quite some time,” said Tan Han, chief fixed-income analyst at Guotai Junan Securities.

“It’s determined by the fundamentals at both the short and long ends of the curve,” Mr. Tan said.
Write to Shen Hong at hong.shen@wsj.com

SHANGHAI–A stubborn anomaly in China’s $1.7 trillion government-bond market has worsened, as an odd combination of tight funding conditions and economic pessimism pushed long-dated yields well below returns on one-year bonds, the shortest-dated government debt.

In the latest sign of stress in a market pressured by Beijing’s effort to clean up a debt-laden financial system and weak economic prospects, the yield on 10-year bonds fell to 3.55% on Tuesday, compared with the one-year paper’s 3.61%, a situation unseen since June 2013, when an unprecedented cash crunch jolted Chinese markets and nearly brought the nation’s financial system to its knees.

The so-called yield-curve inversion first surfaced a month ago, when the yield on less actively traded five-year bonds broke above that on the popular 10-year bonds. Bond yields move inversely to their prices.
The anomaly deteriorated two weeks later and took on a rare, new form: the yield on the illiquid seven-year bonds rose above those on both the five-year and 10-year paper, squeezing the curve into a shape that resembles a triangle.

An inverted yield curve defies common understanding 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.

When the U.S. Treasury yield curve inverted in 2006 and 2007, most analysts cited Asian central banks’ heavy buying of longer-dated U.S. government debt.

“But the curve inversion we are seeing right now is one with Chinese characteristics and it’s different from the previous one in the U.S.,” said Deng Haiqing, chief economist at JZ Securities.

The current anomaly in the Chinese bond market is partly the result of mild inflation and expectations of a slowing economy, Mr. Deng said. “At the same time, short-term interest rates will likely stay elevated because the authorities will keep borrowing costs high so as to facilitate the deleveraging campaign,” he said.

Since last summer, Beijing has embarked on a campaign to reduce long-term financial risk caused by reckless lending behavior among banks and leveraged investing that has created one asset bubble after another.

The effort intensified in February and March when the People’s Bank of China raised a suite of key money-market interest rates, which has since pushed up yields across the bond curve, especially those on short-dated tenors.
As a result, the one-year bond yield rose to a 31-month high of 3.66% on Thursday, while the increase in the yield on 10-year bonds has lagged behind.

In fact, the 10-year yield has fallen more quickly than its short-dated counterpart since Monday, when a brief, largely speculative rebound in bond prices emerged after Beijing sent somewhat soothing messages on its deleveraging campaign, analysts say.

In an article published Saturday, the central bank’s flagship newspaper, Financial News, said that the severe credit crunch four years ago won’t repeat itself this month because the central bank will keep liquidity conditions “not too loose but also not too tight.”

Chinese financial markets tend to be particularly jittery come June due to a seasonal surge of cash demand arising from corporate-tax payments and banks’ need to meet regulatory requirements on capital.
On Sunday, the official Xinhua News Agency ran a similar commentary that sought to stabilize market expectations. “Don’t panic,” it urged investors.

“The authorities’ soothing rhetoric certainly helped drive down yields and I think even if the curve inversion disappears one day, the curve will look pretty flat for quite some time,” said Tan Han, chief fixed-income analyst at Guotai Junan Securities.

“It’s determined by the fundamentals at both the short and long ends of the curve,” Mr. Qan said.