China – U.S. 10-yr Treasury Yield Spread lowest - Likely PBOC reaction
The China-U.S. yield spread which is the main channel through which U.S. interest rates affect the yuan and capital flows -- has narrowed to a critical level. This is mainly due to rise in the U.S. 10-year treasury yield – amid reconciliatory remarks on reducing the trade friction and increase in risk appetite among the market players.
In the past five years, the China-U.S. yield spread fell close to about 50 bps three times – Dec’15, Nov’16, and Apr’18. The previous two periods noticed a subsequent recovery in China’s bond yields. With the historic low yield spread, there has been precedence of People’s Bank of China (PBOC) responding to the situation by guiding the market rates higher and subsequently pushing the spread back to the comfortable level. PBOC’s move is also likely to be guided by the Fed’s rate hike trajectory in the coming months. With more Fed rates hikes building up than previously anticipated and a low spread between the yields in China-U.S. treasury, an inflection point for Chinese yields could be on the cards. This is likely to get PBOC to nudge up market rates to have sufficient buffer between the two treasury instruments.
Earlier in April, PBOC stated that the spread of about 100 bps was within a comfortable zone. Since then, the spread shrunk to lowest point of 58 bps on 24th April 2018 before moderately recovering to 69 bps towards the end of the month.
The PBOC has a number of tools it can use to guide up market rates. One way is to reduce liquidity injections in the interbank market. It is more likely for PBOC to raise interest rates on its policy tools, including the short term reverse repo and medium-term lending facility.
Chief Manager (Global Credit Risk Management Group) at ICICI Bank || IIM Kashipur- All Rounder Gold Medalist
6 å¹´Intriguing and very well written.