China’s bond traders defied signs of intervention to push sovereign yields to a record low, setting up the stage for a showdown with authorities seeking to tame the blistering debt rally.

The yield on the most actively traded 10-year sovereign notes slid to 2.075%, a level unseen since official record became available in 2002. The move came even as state banks were seen becoming more active in selling long-dated bonds in the secondary market in recent days, a sign the People’s Bank of China (PBOC) may have intervened to cool the rally. 

The development underscores a wide difference between where traders and Chinese policymakers think government yields should be. While the former only want to get their hands on the safest assets amid a moribund economy and prolonged property crisis, the latter is concerned that a burst of a liquidity-fuelled bubble can jeopardise financial stability.

“The PBOC will intervene more aggressively to sell bonds and lift yield from time to time, but yields will still likely trend down with a floor at 2%,” said Gary Ng, a senior economist at Natixis. “It will take a big improvement in the economy and corporate profits to reduce the bearish sentiment.”

Chinese President Xi Jinping became the latest boost to the bond rally, as he called on government officials at all levels to achieve the country’s annual growth target. To some, that means Beijing will need to ease its monetary policy to support growth, a move typically leads to lower debt yields.  

Also bolstering bullish bets on bonds was a report that China is poised to cut interest rates on more than US$5 trillion of outstanding mortgages as early as this month. The PBOC injected short-term cash into the banking system in its open-market operations for a sixth straight day on Friday, again benefiting the debt market.

Key indicators - including credit growth, retail sales and fixed-asset investments - that are scheduled to be released in the coming few days will drop a hint on China’s economic health. Analysts are expecting to see weakness in nearly all the upcoming data for August.  

Traders have been on tenterhooks since last month, when Beijing’s pushback against the bond rally evolved from verbal warnings to direct intervention. For days, state lenders were seen selling a 10-year special sovereign bond that’s mostly owned by the PBOC, according to traders. 

The move helped to drive the turnover on the debt to more than 15 billion yuan in every session since Tuesday, compared with just 2.2 billion yuan on Monday. The Shanghai Securities News said earlier this week that debt selling by the PBOC will likely continue. 

Before wading directly into the debt market, the officials have warned financial institutions that crowded holdings in debt positions could easily turn into a “stampede” in the event of a sharp yield reversal. Officials are also wary of the 2023 collapse of Silicon Valley Bank which piled into US Treasuries before a market reversal.

“PBOC’s action seems to be not forceful enough to back yields,” said Stephen Chiu, the chief Asian foreign exchange and rates strategist at Bloomberg Intelligence. “But we still believe that the PBOC would have to step up to back the longer-end yields. I guess market will try PBOC’s tolerance and push 10-year yield all the way towards 2%.”

  - Bloomberg