(Yicai) July 23 -- Asset managers remain optimistic about China's treasury market even though speculators say the central bank could start selling long-term government bonds to stop a plunge in yields.

The positive prospects of medium and long-term notes remain unchanged and the market dances to the tune of the People’s Bank of China even though the falling interest rates on deposits could further drive declines in loan rates, according to New York-based investment titan BlackRock. 

The yield of 10-year treasury bonds dropped 1.95 bips to 2.241 percent yesterday and that of 30-year treasuries declined by 1.2 bips to 2.451 percent as the latter once again fell below the rate of medium-term lending facility loans, prompting speculation of the PBOC planning to borrow and sell bonds to boost yields to stabilize an overheating market.

New Strategies

The PBOC is revising its playbook to help bolster the country’s economic recovery. 

The central bank yesterday made a surprise move of linking up an interest rate cut in short-term open market operations with a mortgage benchmark reduction, signaling a move away from its longer-maturity tool of MLF loans to guide liquidity in the banking system.

In specific, the PBOC yesterday lowered the interest rate of its seven-day reverse repo operations to 1.7 percent from 1.8 percent, marking the first cut since August, surprisingly before the Federal Reserve's next move. Moreover, China's one-year and five-year loan prime rates were trimmed by 10 bips to 3.35 percent and 3.85 percent, respectively. The first decrease in the two benchmark rates for commercial banks was done in February when the five-year LPR was pared by 25 bps. 

The PBOC also said yesterday that from this month, financial institutions that want to sell medium and long-term bonds can apply for a staged reduction or exemption of MLF loan collaterals in an effort to increase the scale of bonds available to ease supply famine.

The central bank has already penned agreements to borrow government bonds from major financial institutions to facilitate selling. Early this month, it told Yicai that the organizations that have joined the program have medium and long-term treasuries worth hundreds of billions of yuan to lend. 

Bond Rally

Experts still believe in strong bond demand. 

Liu Xin, director of fixed-income investment at BlackRock, said to Yicai that the market of long-maturity bonds should continue rising in the long run due to policy boost but bonds with variable interest rates are expected to fluctuate in the short term even though their medium to long-term outlook is still optimistic.

Although the yields of Chinese treasuries are much lower than those of the United States, the returns are still considerable due to foreign exchange rate hedging as the PBOC assures currency rate stability, Liu added.

Morgan Stanley Huaxin Funds, a Chinese mutual funds business of the American investment bank, said to Yicai that bad news is unlikely for the bond market as interest rate risks are low and buying is generally feasible. However, investors are advised to pay attention if the yield of 10-year treasury bonds gets close to 2.2 percent and that of active 30-year treasury bonds nears 2.4 percent.

Slashing the rate of seven-day reverse repo operations and the potential bond sales of the central bank could result in higher yield curves, said Lu Ting, chief China economist at Japanese financial giant Nomura.

Still, the LPR cut will reach existing loans only in January so the PBOC is likely to push commercial banks to lower their existing mortgage rates in the next few months, Lu added.

Editor: Emmi Laine