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source from：WSJ
MARKETS
China Markets Stress Reaches Bonds
Yield on the benchmark 10-year government bond hits 20-month high; rout follows stock selloff
By Rachel Rosenthal
April 25, 2017 6:40 a.m. ET
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China’s government-bond yields hit their highest levels in 20 months, the latest sign of stress in the country’s markets as officials crank up their rhetoric about containing credit growth and financial risks.
The yield on the benchmark 10-year bond rose to 3.515% on Tuesday, the highest since August 2015, up from 3.493% late Monday and 3.276% about a month ago. Yields rise as bond prices fall.
The rout follows a selloff in Chinese stocks in recent days: The main benchmark in Shanghai slid 1.4% on Monday, its biggest daily drop since December.
While stocks regained some ground on Tuesday—closing up 0.2%—the swings indicate the near-impossible task officials have set themselves this year: maintaining market stability while curbing financial risks and slowing runaway credit growth. In an editorial published Monday in China’s state-run Financial News, the country’s central bank cited asset bubbles and rising leverage as the biggest risks to the financial system.
At the eye of the recent storm lies fresh criticism from regulators of the plethora of investment products sold by banks with the promise of higher returns than standard deposit accounts deliver. A particular focus now are so-called entrusted investments—pools of customer money that Chinese banks hold, some of it off their balance sheets, and channel to outside asset managers to invest. Regulators are concerned these investments have helped stoke markets from corporate bonds to soybeans in recent years.
While there are no official data, entrusted investments exploded to between 5 trillion yuan and 6 trillion yuan ($726 billion and $871 billion) by the end of 2016, according to research by Sinolink Securities , a brokerage. At least 80% has been funneled into China’s bond market, analysts say.
They represent just a small slice of China’s shadow-banking system, which regulators are trying to shine more light on, and whose assets as of mid-2016 stood at 58 trillion yuan ($8.42 trillion)—roughly 82% of gross domestic product—ratings firm Moody’s Investors Service estimates.
“Shadow banking has been growing very quickly,” said Jean-Charles Sambor, deputy head of emerging-market fixed income at BNP Paribas Investment Partners in London. “[Regulators] want to improve transparency. The gray areas are becoming less gray.”
Market players fear regulators will limit sales of entrusted investments. That could weaken demand for bonds, which retail investors can’t buy directly, said Frances Cheung, head of Asia ex-Japan rates strategy at Société Générale in Hong Kong.
‘[Regulators] want to improve transparency. The gray areas are becoming less gray.’
—Jean-Charles Sambor, BNP Paribas Investment Partners
Still, some investors say increased scrutiny of shadow banking is encouraging, even if it causes the market to swoon.
“It’s healthy volatility,” said BNP’s Mr. Sambor. “It’s one more tick in a very welcome box.”
The ramp-up of credit growth started in 2015, when the People’s Bank of China lowered short-term borrowing rates to juice the sluggish economy. Many investors used the cheap funds to buy financial products. Much of the money ended up in bonds, which investors often then used as collateral to buy even more financial assets.
But last summer Chinese officials started making short-term borrowing more expensive. In July, the central bank stopped providing banks with cheap three-month loans and over the following months started offering pricier one-year loans instead. This year it has twice raised the cost for banks to borrow from each other, and analysts expect further increases this year.
Despite the moves in stocks and bonds, China’s currency—often viewed as a barometer of risk—has been relatively stable recently. China has spent $1 trillion in reserves over the past 2½ years to keep the yuan from sliding against the dollar and prevent money from flooding out of the country.
Those efforts have paid off: The yuan has risen 1% against the dollar this year, including 0.1% in April. One-month implied volatility for the dollar-yuan exchange rate has dropped to its lowest level since 2015. Implied volatility is based on options prices, and typically rises if investors expect big moves in the next month, as that drives up demand for the protection options provide.
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