Well, here’s what we said last night:
Chinese Shares Tumble, Shanghai Composite Down Most in 11 Weeks
Party Congress over: sell!
— Walter White (@heisenbergrpt) October 30, 2017
Things were a bit dicey in China in Monday, although it calmed down by the time the session ended. One ongoing issue is rising yields. Yields on the 10-year rose by as much as 10bps at one point, the most since mid-December. They’re now the highest since 2014:
The 5-year yield jumped 11 basis points to 3.99%.
As you’re probably aware, the curve inversion issue is ongoing over there:
As Bloomberg notes, “trading volume of generic five-year government bond futures was last at 25,080 lots, the highest since January 2016; that on 10-year contracts was at the highest since June this year.”
One worry here is that this will finally spill over into corporate bonds, which have thus far remained resilient in the face of rising sovereign yields.
There are questions about what would happen in the event the PBoC is forced to hike OMO rates again to respond to the Fed hike in December. That has the potential to trigger an unwind in entrusted deals (remember those?) which, if you recall, started blowing up last December in the wake of a Fed hike.
“Sentiment is still fragile — as the government bond yield keeps hitting new highs, market sentiment is only getting worse and worse,” SWS Research’s Meng Xiangjuan writes, in a new note, adding that “irrationality will accelerate the declines of bonds.” It’s a good thing Chinese investors are known for being rational and remaining calm under fire…
“China is facing the toughest financial regulations ever,” Huachuang’s Qu Qing says, adding his voice to the chorus. “The adjustment in bonds will continue and yields will climb this year. Investors should be cautious, and shouldn’t bottom fish before a clear floor appears.”
Right. “Don’t bottom fish until a clear floor appears.” And Chinese equities did indeed stumble on Monday, with the SHCOMP falling 0.8% for its worst day since the aftermath of “fire and fury” in early August:
It was even worse for the Chinext, which fell more than 2%:
“The surge in China’s government bond yield last week and expectation for tighter financial regulation have triggered concern of tighter liquidity,” Qiu Zhicheng, a strategist at ICBC International Research Ltd. in Hong Kong told Bloomberg. “This prompted the slide in small caps as their valuations are still expensive, and thus they are more sensitive to changes in liquidity conditions.”
You get the idea – trouble brewing just after the Party Congress ends. Who knew, right?
Oh, and finally, you want to keep an eye on the PBOC’s 63-day reverse repo ops. The 63-day variant is new and is pretty clearly designed to try and smooth things out into year end. It will be tested bigly as more than CNY1 trillion of yuan of liquidity matures this week.