China Takes a Fancy to Yield Control

Almost a decade after China loosened the shackles on its currency, authorities are trying to strengthen their grip on the bond market. Beijing hasn’t quite swapped one peg for another, but has developed a dim view of low long-term interest rates. The desire for greater influence over yields won’t come without a cost. Something will have to be sacrificed, or at least curtailed. That something is likely to be the scope to juice growth.

Officials have been signaling for months that they’re uncomfortable with the rally in government bonds. The yield on 10-year notes fell to a record 2.18% last week; those for 20 and 50 years have hovered around historic lows for months. The retreat largely reflects disappointment at the pace of economic growth and anemic levels of inflation. The price surge that accompanied the reopening of other economies was absent. China has the opposite challenge: fending off deflation. The reaction of investors to these underwhelming conditions is fairly textbook.Less orthodox is the pushback. Rather than merely grumbling about yields, the central bank amassed the firepower to do something about it. The People’s Bank of China said on July 1 it will borrow debt from primary dealers with the intention of steadying the market, a decision made after “careful observation and evaluation.” A few days later, the PBOC revealed that it has hundreds of billions of yuan at its disposal. The idea appears to be that if yields drop too far, the central bank will signal displeasure by selling bonds to push rates up — or at least cushion the descent. Where might this line in the sand be? According to Gavekal Dragonomics, authorities are putting a floor under 10-year yields at around 2.2%. 

It’s possible that China can achieve at least some of its goals without spending too much, if anything at all. Knowing that the state muscle is there to greet enthusiastic traders may be enough of a deterrent. At the very least, bulls will think twice. In that sense, it’s a little like foreign-exchange intervention. Supposed lines in the sand frequently get moved around, though the general intent to slow investors down still remains. And as with currencies, officials can score some short-term wins while acknowledging that the underlying conditions of the economy will ultimately drive the outcome. Just ask Japan, which spent $62 billion in May to slow, not reverse, the yen’s dive. 

In the case of the yen, the canyon between official interest rates in Japan and the US is responsible for much the weakness. In China, the bond rally wouldn't have had the same steam if the economy and prices had a bit more zip. The country “appears to be heading for a sustained period of near-zero inflation and weakening trend growth which, coupled with a high debt burden, points to further declines in nominal rates over the medium term,” wrote Julian Evans-Pritchard of Capital Economics in a recent note. “If we are right, then the best the PBOC can probably hope to achieve is to stabilize yields around current levels for a few quarters, but not indefinitely.”

Why is China so up in arms about low long-term interest rates? Plenty of countries would applaud such a development, provided it happened for the right reasons. Modest yields allow governments to borrow cheaply and tend to be interpreted as sign of confidence. The demise of Silicon Valley Bank in the US was, however, a cautionary tale, as my Bloomberg Opinion colleague Shuli Ren has written. SVB loaded up on long-term Treasury securities. When rates soared, a consequence of the Federal Reserve’s effort to quash the price surge of 2021 to 2022, the value of SVB’s holdings plummeted. One key distinction is that the Fed was battling inflation; the PBOC isn’t. 

There might be an unfortunate byproduct of putting a floor under yields. If policymakers want to lower interest rates, it would act as official confirmation — if more were needed — that all is not well in the economy. This may at least partly explain the PBOC's reluctance to ease. 

When China's recovery began to disappoint last year, it became fashionable to compare and contrast with Japan, whose markets were soaring and where the central bank was laying the ground to dismantle its ultra-easy apparatus. A few months ago, the Bank of Japan formally ended efforts to keep 10-year bond rates near zero. But the desire to control yields hasn’t been entirely banished. Just ask China.More From Bloomberg Opinion: 

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Daniel Moss is a Bloomberg Opinion columnist covering Asian economies. Previously, he was executive editor for economics at Bloomberg News.

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