Chinese Yield Curve Remains Well Behaved, Despite Taper Tantrums Elsewhere

Summary

• As well as low correlation with G7 yields in recent years, the Chinese 10s/2s yield curve has been more stable than most G7 yield curves in recent years, despite the PBOC not pursuing QE or formal yield curve control (unlike the BoJ).
• Unlike the US, there are few signs of inflation risks having climbed towards the top of investor concerns in Chinese 7-10yr bonds, or market anxiety that the central bank may be in danger of getting behind the inflation curve, which has caused US 10-year yields to rise sharply.
• The period of stability in yields central bank QE purchases and yield curve control can deliver is often ended by periods of high volatility as markets speculate about exit strategies from QE, or increased inflation risks.

By Robin Marshall, Director, Fixed Income Research, FTSE Russell

Apart from a 2020 COVID-19 spike, the Chinese yield curve has been stable since 2016

As well as low correlation with G7 yields in recent years[1], the Chinese 10s/2s yield curve has been more stable than most G7 yield curves in recent years, despite the PBOC not pursuing QE or formal yield curve control (unlike the BoJ). Since 2016, apart from the brief COVID-19 spike, the 10s/2s curve has moved within a narrow range of about 60 basis points. Even after the spike during the COVID-19 pandemic in February 2020, Chinese yields and the yield curve rapidly mean-reverted, as Chart 1 shows. This is very different from the US Treasury curve, which has experienced far larger swings over the last five years, first flattening by about 140bp, and then steepening by about the same amount since COVID-19.

Chart 1:

Source: FTSE Russell, data as of February 28, 2021. Past performance is no guarantee to future results. Please see the end for important disclosures.

Instability in the US yield curve is due partly to pronounced swings in Fed policy rates and 2-year US yields, but also much higher volatility in 7-10yr yields than China. After tightening from 0 - 0.25% in Fed funds to a high of 2.5% - 2.75% in Q4 2018, the Fed reversed its policy stance and reduced interest rates back to 0.25% in 2020, causing 1-3yr yields to decline almost 300bp in the process (see Chart 2). But Chinese short-dated yields have also been volatile. Yields first rose when the PBOC tightened policy to slow the credit boom in the period 2016-18 before falling sharply as markets discounted a significant policy easing in response to the COVID-19 shock in 2020, which has never materialized.

Source: FTSE Russell, data as of February 28, 2021. Past performance is no guarantee to future results. Please see the end for important disclosures.

With no QE, the Chinese govt. bond curve is less prone to Taper Tantrums…

The bigger contrast is in the stable performance of Chinese 7-10yr yields versus the US, as Chart 3 shows, despite the PBOC not pursuing QE or yield curve control. Unlike the US, there are few signs of inflation risks having climbed towards the top of investor concerns in Chinese 7-10yr bonds, or market anxiety that the central bank may be in danger of getting behind the inflation curve, which has caused US 10-year yields to rise sharply.

…unlike other central banks, which will need to judge QE tapers at some stage

This contrast suggests a complexity in central bank QE programs, and indeed formal yield curve control. The period of stability in yields central bank QE purchases and yield curve control can deliver is often ended by periods of high volatility as markets speculate about exit strategies from QE, or increased inflation risks. Both the Taper Tantrum in 2013, and the sharp back-up in yields in 2020/21 are evidence of this. The larger central bank holdings of government debt become, as a share of total issuance, the more demanding QE exit strategies may be. The PBOC may therefore be thankful it does not have to contend with those issues in 2021/22.

Source: FTSE Russell, data as of February 28, 2021. Past performance is no guarantee to future results. Please see the end for important disclosures.

[1]See FTSE Russell China Bond Report, November 2020

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