China's central bank, the People's Bank of China (PBOC), announced a significant policy shift on Friday, suspending its government bond purchases. The decision comes as China's 10-year bond yield plunged to a record low this month, prompting concerns about market dynamics and the yuan's stability. The PBOC attributed the suspension to a shortage of bonds and signaled it would resume buying once the supply-demand balance shifted. This move is part of a broader strategy to stabilize the yuan and manage economic pressures amidst slower growth domestically and widening yield gaps with U.S. bonds.
The PBOC's bond purchasing program, which officially began last year, aimed to support the bond market and control yields. However, a recent plunge in yields raised alarms about excessive downward pressure on the yuan. The yield on Chinese government 10-year bonds currently stands at approximately 1.64%, significantly lower than the U.S. Treasury's 10-year bond yield of 4.68%. This widening gap has put additional pressure on the yuan exchange rate, prompting the PBOC to take corrective action.
"The PBOC is trying to cool down the market by suspending government bond buying," said Larry Hu, chief China economist at Macquarie.
In an effort to maintain market stability and discourage speculative behavior, the PBOC announced its decision before markets opened on Friday. The central bank seeks to slow a one-way bonds trade that has contributed to unwanted downward pressure on the yuan. By halting purchases, the PBOC aims to push yields of longer-term bonds "back to a reasonable level, and also help stabilize the RMB exchange rate."
"The PBOC may be attempting to signal to all market participants that rates have come down too low and too fast," remarked Peter Alexander, founder of Shanghai-based consulting firm Z-Ben Advisors. "Their stepping away should lead to a rise in rates at least for the short term."
The Chinese yuan traded in Hong Kong strengthened slightly on Friday following the announcement, reflecting market expectations for tighter monetary policy. Meanwhile, the greenback has climbed on expectations of continued U.S. economic resiliency, further complicating China's economic landscape.
Brian Tycangco, an analyst at Stansberry Research, noted the impact of the PBOC's decision on market transparency:
"Unfortunately, suspending buying of bonds will reduce the transparency of pricing in the domestic bond market, making it a little more difficult for market participants to execute orders."
The decision also aims to address high demand for bonds driven partly by expectations of substantial stimulus measures in 2025 to combat weak consumption and deflationary pressures.
"The unusually high demand for bonds is also likely being driven by in part by growing expectations of a big stimulus in 2025 to address weak consumption and battle deflationary pressures," Tycangco explained.
The PBOC is employing a basket of tools to signal yuan stability while supporting a gradual decline in yields. As part of this strategy, the central bank plans to auction 60 billion yuan in six-month bills in Hong Kong on January 15. This move is expected to help manage liquidity and stabilize market conditions.
Lynn Song, chief economist at LNG, commented on the immediate market reactions:
"The immediate impact has been a small move of yields higher. However, we expect this impact to be relatively short-lived if the PBOC is only pausing rather than defending a specific yield target like they did last year; the factors driving bond yields lower such as weak market confidence leading to heavy demand for safe sources of yield remain in place."
As China grapples with slower economic growth domestically, the decision to suspend bond purchases reflects a strategic approach to balance internal and external pressures. The PBOC aims to prevent speculative activity that could exacerbate yield drops while maintaining overall economic stability.