The ‘Dollar’ Devil Shows Itself Again In China

Some economic and financial conditions leave a yield curve as a more complex affair. Then there are others that are incredibly simple. The UST yield curve is the former, while right now the Chinese Treasury curve is the latter. Even still, the media manages to make it something it isn’t because the world from its perspective is surely improving, and Chinese money is tight for prudent reasons of intentional policy.

A stubborn anomaly in China’s $1.7 trillion government-bond market has worsened, as an odd combination of tight funding conditions and economic pessimism pushed long-dated yields well below returns on one-year bonds, the shortest-dated government debt.

RMB markets are indeed “tightening”, so longer-dated government paper continues to reflect the consequences of that condition, even now to more extreme levels. For an economy already precariously positioned given the events of the last few years, it’s not a trivial concern.

It is not so much inverted as heavily malformed, though in truth that is more pedant semantics than analysis. There is no question as to the first part, just as there isn’t for the second. What seems to be misunderstood is the reasoning for what is taking place at the short end.

What is going on here is nothing short of disorder. There is simply no way to characterize it as a product of intentional monetary policy. To begin with, the PBOC doesn’t operate (ever) with such messy design. China’s central bank has in its history operated with a much more conditioned approach, even when their method and intent have been misguided or mistaken. The appearance of almost open chaos in 2017 brings to mind RMB conditions in the middle of 2013 – the last time the treasury curve inverted.

After having experienced that degree of illiquidity four years ago, Chinese authorities instituted rather quickly additional liquidity channels so as to avoid ever again those circumstances. It’s not as if the PBOC has sat out this last year, either. They have been heavily, hugely engaged using just those means, but to no further avail.