Is China More Concerned by Plunging Bond Issuance Than Fed Rate Hikes?

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Some analysts expect the Chinese central bank to keep rates steady despite anticipation of a further rate hikes by the US Fed, with Beijing highly concerned about the impact of plunging corporate debt issuance upon China’s economic growth.

The Federal Open Market Committee is expected to raise its benchmark rate for the third time since December at its meeting on Wednesday, trimming away further at the interest rate and bond yield disparity between China and the US.

The spread on Chinese 10-year sovereign bonds against US 10-year Treasuries fell from 150 basis points in December 2014 to under 80bp this year following the Fed’s rate hike in March.

While the People’s Bank of China has kept its one-year deposit rate at 1.5% since 2015, the US Fed Funds Rate has risen to 1% from 0.25% in December, with analysts anticipating another quarter-point increase this week.

Chinese policymakers have previously fretted that rate hikes in the US could exacerbate capital outflows, yet some analysts now expect them keep rates steady irrespective of the Federal Reserve’s actions.

Following the Fed’s rate hike in March, PBOC lifted rates for short-term reverse repos and loans via medium-term lending facilities by 10 basis points, pointing to the Fed rate rise specifically as one of its reasons alongside rising corporate profits and low real interest rates.

Yu Yongding, a leading Chinese economist as well as former advisor to PbOC, said to The Financial Times that China needs to keep rates stable, and that there is not need for it to follow the Fed.

“It won’t have much of a market impact,” said Yu of the anticipated Fed rate rise, pointing to other tools available to Chinese regulators, as well as the effectiveness of capital controls which could check any interest-rate motivated outflows.

According to one source who spoke to FT, PBOC officials are far more concerned with the impact of a sharp decline in bond issuance on China’s economic health, following the rise in interbank rates and tightened liquidity caused by an ongoing deleveraging drive.

Corporate bond financing in China plunged to negative 217 billion yuan in May, on the back of a record low for new issuance.

“Short-term interest rates have already come up a lot in China and financial regulation has meant a de facto tightening of financial conditions,” said Andrew Batson, head of China research at Gavekal Dragonomics, in recent note. “The central bank is unlikely to desire to see rates rise further.”

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