(Bloomberg) -- The People’s Bank of China’s decision to halt bond buying is exacerbating the rise in short-end rates and flattening the yield curve, spurring bets the central bank may resume government debt purchases.
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China’s one-year bond yield spiked over 20 basis points this month, narrowing its gap with the benchmark 10-year bond to the smallest since December 2023. That’s after the PBOC earlier in January said it will suspend sovereign bond purchases, in an attempt aimed at reining in the bond rally and supporting the currency by reducing liquidity.
A delay in PBOC’s interest-rate cuts due to mounting depreciation pressure on the yuan, as US President Donald Trump threatens to impose higher tariffs on China, is also pushing up short-end rates. China’s seven day repo rate spiked to the highest in nearly two years last week signaling the extent of liquidity tightness.
“This is the result of PBOC stopping bond buying,” Xing Zhaopeng, a senior strategist at Australia & New Zealand Banking Group Ltd. said referring to China’s flattening yield curve. “The front end is impacted by delay of rate cut,” he said.
Xing expects the PBOC to try to keep an upward sloping curve. “So it will buy the front-end likely in the second quarter,” he said.
A flattening yield curve is usually seen as a bearish signal over a country’s longer-term growth prospects. PBOC Governor Pan Gongsheng and his predecessor Yi Gang have both spoken about their desire to maintain a “normal, upward sloping” yield curve in recent years. This incentivizes the market to invest, Pan said in June.
However, China’s failure to break its deflationary cycle, that’s now in its longest stretch since the 1960s, is likely to put long-end yields under pressure and flatten the curve. The nation’s 10-year yields fell below 1.6% this month for the first time ever. They’re still just around six basis points above that level.
Central bank’s liquidity operations signal its desire to maintain tighter cash conditions for now. The PBOC withdrew a net 795 billion yuan ($109.6 billion) through medium-term policy loans on Friday while keeping the interest rate unchanged at 2%.
“Looking ahead, the curve will stay flat, given the weak inflation expectation,” said Samuel Tse, economist at DBS Bank in Hong Kong. “In any case, the PBOC will likely resume bond buying. The weak inflation and credit demand will prompt the PBOC to stay on an easing stance. With this in mind, easing measures like bond buying will likely resume,” he said.