Chinese bond yields plunged to a record low and the government authorities halted trading in some of the future contracts so as to avoid selloff of the corporate bonds. Despite the mainland’s capital controls, its bond market joined the global market ructions after the U.S. Federal Reserve announcement of a hike in interest rates by three times in 2017, rather than the previously forecast of two hikes. The Federal Reserve also hiked its interest rate by 25 basis points, as was widely expected, to a target range of 0.5 to 0.75 percent, only its second rate hike in a decade.
WHY THE BOND CRASH?
As a dispel in Chinese stocks this year erased $5 trillion of the Chinese stock market value, investors thus fled for safety in the nation’s red-hot corporate bond market. The stock market was wiped off by around 30% of the total value of the Chinese stock market. Due to this, investors started selling shares. They however thought that the safer Chinese bond market could provide them with better returns. But they may have just moved from one bubble to another. Due to surge in supply of investors to buy government and corporate issued bonds, the government reduced the bond rate. The rates however hit an all-time low with the announcement of the benchmark rate hike by the US Federal Reserve. Chinese authorities therefore, halted trading in key bond futures for the first time as panicked investors sold the securities on concern that a long, credit-fuelled bull market was coming to an end amid slowing consumption and export led growth, capital outflows from the country and heightened government concern about asset bubbles and easy credit.
Chinese investors believe that the government will increase the interest rate because of the devaluation of Chinese Yuan against the Dollar and also to curb increasing capital outflows from the country due to negative sentiment and volatility. However, China has its own unique set of problems to deal with. The local bond market slump also exacerbates the policy dilemma facing China’s central bank. Chinese Government also tightened short-term lending recently in an effort to make it harder for speculative investors to borrow money. The problem is that such tightening moves, along with any future rate rises, could in turn provoke market plunges and panic as liquidity dries up in the economy. Also it would bring down the Investment and the Consumption part of the GDP which in turn could bring the growth rate even below 6% this time.
EMERGENCE OF BITCOIN
With the growing concerns about the speed of capital outflows and the depreciation of Renminbi the investors may be looking as Bitcoin as an alternative.
According to a report from CoinDesk Data, Bitcoin rose up to $788.49 in Asia trading on the 13th of December 2016. This was the highest intraday level since 6th of February 2014. In contrast, The Shanghai Composite Index had fallen by 0.7 per cent and the Shenzhen Composite Index had reduced by 0.6 per cent. According to CoinDesk, Chinese exchanges contribute to a almost 95 percent of all of global Bitcoin trading.
Bitcoin is a virtual currency that does not need a central authority to move money around the world in an instant. This is what makes it attractive for people who seek to find a way around strict capital controls in China.
With the Chinese Regulators shutting down the bonds market trading in order to avoid a complete collapse, more money will have to flow into alternative assets. The bond market crash would bring more attention to Bitcoin which will lead to an increase of its value in the coming weeks.
China must start to curb the relentless rise of debt in the system. The assumption that the government of Xi Jinping will keep bailing out its banks, borrowers and depositors is pervasive. It must tolerate more defaults, close failed companies and let growth sag. This will be tough, however it is too late for China to avoid pain. The task now is to avert something far worse. This crash is just the start and will add to broader concerns about the Chinese economy, which grew at its slowest pace in more than 25 years in 2016, weighed down by a growing debt load and money-losing state-owned industries. To stem the outflows, authorities are using measures such as restricting overseas company acquisitions—transactions that could be fronts for spiriting money out of the country.
But the worst news is that in an economy driven entirely by cheap, abundant credit, the consequences of the bursting of the bond bubble will only emerge in the coming weeks as China’s economy slows down dramatically, which in turn will spill-over to both the global economy and capital markets. The only question is when.
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