PBOC emerges as ‘reliable boyfriend’ for bond markets

While Western central banks send confusing signals about rate rises, Chinese policymakers’ message of stability is loud and clear

Amood of mistrust pervades global bond markets. Investors have been piling pressure on leading central banks in the past few months, calling on them to explain how they intend to prevent the surge in inflation from getting out of hand without endangering the recovery. The signals from central banks have been confusing and, in some cases, misleading.

The disconnect is most apparent in Britain, where the Bank of England’s decision last week not to raise rates despite having strongly hinted that they could rise this year stunned investors.

The move sparked criticism that Britain’s central bank was once again behaving like an “unreliable boyfriend”. It was the same accusation levelled at it in 2014 when it flirted with – and then rejected – higher borrowing costs.

Other central banks, notably those in Australia and Canada, have also confounded investors. Their decisions are fuelling uncertainty about the severity of the threat posed by higher inflation and causing intense volatility in short-term government bonds.

The challenges faced by the US Federal Reserve, which has gone to great lengths to convince markets that the reduction in its asset purchases is not a signal that rate increases are imminent, have become more acute. Markets expect the Fed to begin raising rates as soon as next September.

However, one central bank has proved adept at guiding market expectations. The People’s

Bank of China (PBOC) has emerged as a bastion of stability and predictability amid the confusion over the conduct of monetary policy in Western economies.

It’s true that markets have worries about the wider policy regime in China. They are particularly concerned about the lack of any meaningful stimulus to help cushion the sharperthan-expected slowdown.

Yet, investors have grown accustomed to the normalisation of monetary policy in China. Gone are the days when the PBOC could be relied on to unleash massive liquidity.

In bond markets, its message of stability and restraint has come through loud and clear. In a report published on November 4, JPMorgan noted that markets were pricing in a trivial 22-basis-point rise in the benchmark one-year loan prime rate by the end of next year. The consensus among economists is that the main rate will remain unchanged.

From an Asian perspective, the PBOC looks positively dovish. Markets anticipate proper rate-increasing cycles in India, South Korea and Malaysia, with benchmark rates expected to rise by 174, 138 and 105 basis points respectively by the end of 2022.

Admittedly, there is less pressure on the

PBOC to raise rates. The publication of data on US inflation on Tuesday showed that prices last month rose to a 31-year high of 6.2 per cent year on year. In China, while producer prices have soared, consumer prices increased by 1.5 per cent in October from a year earlier, held down by weak consumer spending.

Yet, other factors are more important in explaining why the PBOC is successful in managing market expectations.

First, Chinese monetary policy has effectively decoupled from its US counterpart. Chinese bonds, unlike those of other leading developing nations, are much less sensitive to movements in US Treasury yields. Not only does this make it easier for the PBOC to steer market rates, it makes China’s higher-yielding government bonds quite appealing from a portfolio diversification perspective.

Second, while the dramatic sell-off in China’s “junk” bonds has damaged sentiment, the combination of surging foreign inflows into the country’s government debt market and a huge trade surplus is boosting banks’ holdings of foreign currency. This makes China less vulnerable to a global shock, reducing pressure on the PBOC to ease policy more aggressively.

Third, China’s central bank no longer has a communication problem, having learned from its blunders following the surprise 2015 devaluation of the yuan. Its messaging over the past several years has been consistent and coherent.

Given the severity of China’s slowdown, the PBOC is bound to come under pressure to provide more stimulus. That bond markets are not expecting a major shift in policy should make its job easier.

China’s central bank no longer has a communication problem