China bonds fall as Yuan drop fuels concern outflows to quicken

China’s government bonds fell on concern a weaker yuan will spur capital outflows, impacting the availability of funds in the financial system.

In a sign of worsening outflows, the People’s Bank of China sold a record amount of foreign currency in December, a report showed Friday, as the central bank stepped up yuan purchases to stem the currency’s slide. The yuan has fallen 1.3 percent this month after dropping 4.5 percent in 2015. The PBOC boosted cash injections in its open-market operations as the seven-day repurchase rate rose the most since November last week.

“The market is concerned capital outflows will be more severe because of foreign-exchange volatility," said David Qu, a rates strategist at Australia & New Zealand Banking Group Ltd. in Shanghai. "The PBOC has used other ways to offset the outflows but the market has been anticipating a cut in reserve-ratio requirements. So when many traders didn’t see one, they just took profits.”

The yield on the 2025 notes climbed three basis points to 2.78 percent as of 11:09 a.m. in Shanghai after reaching an unprecedented 2.70 percent on Thursday, data from the National Interbank Funding Center and ChinaBond show. In the money market, the seven-day repo rate fell six basis points to 2.28 percent, a weighted average from National Interbank Funding shows. It increased three basis points last week.

Yuan Swings

Even so, ANZ’s Qu said he expects bond yields to drop in the longer term as the central bank will ensure that liquidity remains ample. The PBOC added 160 billion yuan to the financial system via seven-day reverse-repo agreements Thursday, up from 70 billion yuan a week earlier. The yuan’s one-month implied volatility, a measure of expected price swings used to price options, has surged 152 basis points in January to 7.70 percent, poised for a third monthly advance.

One-year interest-rate swaps, the fixed cost to exchange the floating seven-day repo rate, gained three basis points to 2.28 percent on Monday, data compiled by Bloomberg show.(Bloomberg)