In Depth: China’s Never-Ending Bond Bull Run Fuels Speculation Regulators May Intervene

Over the past year, significant trading activity has surged in China’s bond market, primarily driven by extensive investment in long-term government bonds [para. 1]. The central bank has repeatedly issued warnings, with some large banks currently being investigated for selling long-term bonds and engaging in illegal transactions, suggesting potential regulatory intervention in financial institutions' bond investments [para. 2].

Since early 2024, yields on 10-year and 30-year government bonds have dropped over 40 and 50 basis points respectively, with prices reaching record highs by August [para. 3]. Experts caution that persistent market trends can build up risk, potentially triggering reversals during external shocks, such as the 2022 redemption wave of China’s wealth-management products [para. 4]. Xu Zhong of the National Association of Financial Market Institutional Investors (NAFMII) emphasizes the central bank’s goal to prevent systemic risks as bond prices surge amid falling yields [para. 5].

While experts predict the central bank is unlikely to directly interfere with financial institutions' decisions, the warnings appear to serve as a caution against overly aggressive investment practices, although some banks have misunderstood this and halted bond trading altogether [para. 6]. On August 5, long-term bond yields hit historic lows, following two interest rate cuts in July that affected various rates [para. 8]. This steep yield decline reflects both falling yields across all credit grades and a growing preference among investors for long-term bonds, prompted by market expectations of rate cuts by the U.S. Federal Reserve and China’s monetary policy shifts [para. 11].

Strategic market manipulation by some financial institutions has further contributed to market volatility, in addition to macroeconomic imbalances [para. 12]. With weak loan demand and lower loan interest rates, banks turned to bond investments, although a slow issuance of government bonds has created a supply-demand imbalance, driving down yields [para. 14]. The volatility has also been driven by speculative trading by smaller financial institutions and individual investors treating bonds like stocks [para. 15]. Small and medium-sized banks are increasingly relying on bond-trading profits, raising concerns about their ability to manage interest rate risks [para. 16].

The flattening yield curve of Chinese government bonds highlights a significant market shift as the central bank emphasizes maintaining a normal upward-sloping yield curve to encourage investment [para. 17]. Following market corrections, analysts speculated on the acceptable range for long-term bond yields, noting that the 10-year yield had reached a 20-year low below sustainable levels [para. 19]. Despite monitoring the risks associated with falling bond yields, the central bank has not set explicit targets [para. 20].

In balancing its policies, the central bank has simultaneously warned against the rapid fall in yields while reducing reserve ratios and interest rates to stimulate the economy [para. 24][para. 25]. Since April, it has issued several risk alerts and suggested possible interventions to stabilize yields, eventually conducting operations to control yields and reiterating warnings about risks tied to heavily bond-invested asset management products [para. 25][para. 26]. Without adequate risk management, aggressive investments by smaller financial institutions could lead to significant impacts reminiscent of the 2023 Silicon Valley Bank collapse [para. 27]. Rural and urban commercial banks' aggressive bond purchasing has contrasted with large banks’ focus on lending [para. 28].

The booming bond market has driven demand for asset management products, raising concerns about mass redemptions if market reversals occur, as seen in 2022 [para. 29]. The central bank’s stress tests are designed to evaluate institutions' vulnerability to bond market fluctuations [para. 34].

Regulators have heightened their crackdown on illegal activities in the bond market, particularly targeting smaller financial institutions for violations such as market price manipulations and illegal profit transfers [para. 36][para. 38]. NAFMII aims to work with the People’s Bank of China to enhance regulatory oversight and introduce stricter rules and sanctions for market compliance [para. 39].