source from：wsj
MARKETS  MARKETS MAIN
China Bonds Send Fresh Stress Signal
For the first time since records began, five-year government-bond yield breaks above the 10-year

By Shen Hong
May 11, 2017 7:08 a.m. ET
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SHANGHAI—China’s $1.7 trillion government-bond market is exhibiting a new sign of stress: The yield on longer-term debt has fallen below that on shorter-term debt—an anomaly that some traders are blaming on Beijing’s efforts to reduce financial risk.

Early on Thursday, the five-year yield rose to 3.71%, breaking above the 10-year yield for the first time since records began—even though the latter, at 3.68%, was near a 25-month high. Yields rise as bond prices fall.

Such a “yield-curve inversion” defies normal market logic that bonds requiring a longer commitment should compensate investors with a higher return. Inversion usually reflects investor pessimism about a country’s long-term growth and inflation prospects. When the U.S. Treasury yield curve inverted in 2006 and 2007, most analysts cited Asian central banks’ heavy buying of longer-dated U.S. government debt.

But in China, while growth has been slowing and inflation has been relatively subdued, few are predicting prolonged deflation or a recession.

“Many of us are scratching our heads for an explanation because this kind of curve inversion is absolutely not normal,” said Wang Ming, a partner at Shanghai Yaozhi Asset Management Co., a bond fund that manages 2 billion yuan ($290 million) in assets.

The answer seems to lie in Beijing’s recent campaign to tamp down the burgeoning shadow-banking sector, whose growth is due in large part to so-called wealth-management products; the amount of such products outstanding has ballooned to $4.2 trillion in the first quarter of 2017, Moody’s Investors Service says, which is more than a third of China’s annual gross domestic product. That is up from $72 billion in 2007, according to Chinese financial data firm Wind Info. Banks sell these products to customers by offering much higher returns than ordinary deposits bring.


But in pursuit of these outsize returns, they often make highly leveraged bets on assets from bonds to stocks to commodities, and that has alarmed authorities. In recent weeks China’s central bank has raised the cost of short-term borrowing while the banking regulator has warned against market “irregularities” such as the explosion of these highly leveraged products.

The crackdown has prompted many issuers to sell bonds in their portfolios to repay investors. While the selling has been broad-based, investors have been ditching five-year government bonds, where the market is less liquid, faster than 10-year bonds, where the market is more actively traded but also cushioned by demand from long-term investors.

“The inversion is a form of mispricing in the bond market,” said Liu Dongliang, senior analyst at China Merchants Bank . “The fact that no one is taking the bargain despite the higher yield on the five-year bond just shows how depressed investors’ mood is.”


The narrowing of the 10-year bond’s yield premium has been particularly conspicuous since April 12, when The Wall Street Journal reported that China’s banking regulator had made a fresh warning to lenders not to engage in speculation that creates asset bubbles and prevents money from flowing to more-productive parts of the economy.

Weak demand for a five-year government bond issued Wednesday further damped interest, traders said. Total bids amounted to 1.8 times the new bond’s 36 billion yuan issue size, lower than the normal ratio of around two times.

“It’s really difficult to predict when the selloff or such anomalies will end because China’s bond market is reacting to the regulatory crackdown only and is no longer reflecting economic fundamentals,” said China Merchants Bank’s Mr. Liu.