China bonds see worst rout in a year, fuelled by surge in inflation

Singapore

CHINA'S benchmark sovereign bond yield jumped the most in a year, as quickening inflation sowed doubts about whether the country's notes can maintain their world-beating advance.

The 10-year government bond yield climbed as much as six basis points to 2.87 per cent on Monday, its biggest rise since July 2020, after eight straight weeks of declines. That's after China's July factory-gate inflation unexpectedly returned to a 13-month high of 9 per cent touched in May. A rise in short-term interbank rates also weighed on government debt.

The surge in inflation is fuelling concern that price pressures in the world's second-largest economy may not be transient. Rising inflation may also complicate potential easing measures from the People's Bank of China (PBOC) and slow the rally in bonds that's partly fuelled by expectations of liquidity support from policy-makers to boost the slowing economy.

"We can't rule out a large correction in Chinese bonds in the short run", following its rapid ascent recently, said Ming Ming, head of fixed-income research at Citic Securities. "The window for the central bank to ease the monetary policy will soon be closed."

China's bonds are still the only gainers this year in the Bloomberg Barclays Global Treasuries benchmark index. That's because the rally - initially sparked by a surprise cut in banks' reserve ratio requirement last month - has extended after worries over regulatory crackdowns spurred haven bids.

A resurgence of Covid cases and signs of weaker activities in the manufacturing sector prompted traders to price in further easing, including a potential interest rate cut.

Further policy cues are expected to emerge from the PBOC's move when 700 billion yuan (S$146.5 billion) of medium-term policy loans mature. If the central bank withdraws cash from the banking system, it would signal concern over inflation but a reduction of the interest rate on the loans would be seen as a dovish move.

The overnight repurchase rate - a gauge of short-term interbank borrowing costs - surged 36 basis points to 2.24 per cent, the highest level in nearly two weeks ahead of the maturity of the policy loans next week.

"The risk of the spread of Delta variant in China cannot be underestimated," said Winson Phoon, head of fixed-income research at Maybank Kim Eng Securities in Singapore before the inflation data release. "Higher PPI (producer price index) is unlikely to derail the prevailing constructive sentiment in China's government bonds, although that market might need cooler heads before pricing in additional easing by the PBOC." BLOOMBERG