Chinese 10-year government bond yields briefly surged to a three-year intra-day high of 3.93% on 1 November, creating concerns over policy tightening and a month-end cash squeeze. This follows a simultaneous sell-off in government bonds and equities earlier this week, underlining investor caution after the 19th Party Congress.
But while we believe investors are right to brace for tighter policy, a gradual rise in rates, and slower growth, we see little to suggest China will pursue this at the cost of financial market stability:
- The People’s Bank of China has responded to higher yields with a liquidity injection aimed at calming bond markets. This appears to have succeeded. Yields at the 1 November Ministry of Finance bond auction came in below both pre-bid forecasts and current secondary market levels, and yields on the benchmark 10-year index have fallen by as much as five basis points.
- Interbank market rates don’t suggest a sudden tilt toward sharply tighter policy. The seven-day repurchase rate has been choppy, but at 3.2% is still well below this year’s peaks.
- China has other measures available. If market turmoil increased, targeted RRR cuts, for example, could be used to help reign in volatility.
We believe China has both the willingness and the ability to balance tighter policy with market stability. We still prefer offshore Chinese equities in our Asia tactical asset allocation, and see China’s economy continuing to contribute to synchronized global growth.
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