China's central bank is set to conduct stress tests on financial institutions' exposure to bond holdings, marking the latest efforts by authorities to rein in a months-long rally and prevent fallout risks.
The People's Bank of China said in its quarterly policy report that the planned checks are aimed at preventing risks stemming from potential rate fluctuations in the future that could dent bond prices and cause financial losses for investors. Bond prices tend to move inversely to rates.
For economists at Goldman Sachs, the statements signal the central bank's concern over mark-to-market risks on Chinese banks' bond portfolios that could spark a Silicon Valley Bank-style collapse. The U.S. lender failed last March when, after having loaded up Treasurys and government-backed bonds, interest rates started to rise quickly and it had to sell assets at a loss while facing a wave of deposit withdrawal requests. The crisis has been frequently cited by Chinese authorities when they warn about rate-related risks.
Friday's report came after a PBOC-backed interbank regulator said last week that it is investigating four rural commercial banks for potential bond market manipulation and had reported some for alleged breaches of regulations. Regulators have also asked mutual funds companies to limit the duration of their new bond funds to two years, a cap that would further restrict funds' investment in longer-dated notes.
Over the past few months, the PBOC has repeatedly warned against the bond rally that has pushed China's long-term yields to multidecade lows as demand for haven assets is fuelled by concerns about the economy. Investors have been seemingly undeterred, with some betting that China's weak economic fundamentals could lead to more rate cuts.
In the policy report, the PBOC also reiterated its bond borrowing plan and intention to restart trading treasury bonds, which some analysts view as signaling intervention.
Any such direct interventions would likely only have a temporary effect, however, as bond yields are ultimately decided by economic fundamentals, economists at Citi said in a recent note.
"A better alternative in theory would be to take action to change market expectations on growth and inflation so as to influence the shape of the yield curve," they said.
Investors who bet that more reductions to borrowing costs are on the cards might be right, economists say.
Weak credit demand, still-low inflation expectations and depressed consumer and business confidence don't support high interest rates in China, economists at Goldman Sachs said.
"We expect interest rates to trend lower in the medium term, as the PBOC may eventually need to lower interest rates further to support the economy and boost domestic inflation," they said in a recent report.
Write to Singapore editors at singaporeeditors@dowjones.com
(END) Dow Jones Newswires
08-12-24 0125ET
