What is China’s $138 billion bond bazooka aiming at?

Shuli Ren, Bloomberg

China [began] selling 1 trillion yuan ($138 billion) special sovereign bonds Friday, the fourth such sale in past 26 years.

These offerings are special in that the government can use them for any purpose. They are not part of the fiscal deficit, so they are not constrained by any budgetary rules.

Indeed, the last three issues showcase the versatility and strategic importance of such bonds. The first was launched in 1998 to recapitalize the big four state-owned banks. The second one seeded the nation’s sovereign wealth fund in 2007. And the third issue was used in 2020 for Covid control and relief measures. That Beijing is reaching out for a

There’s rampant expectation that a big chunk of the money will be used to reduce excess supply in China’s troubled property sector. Investors got excited by the latest Politburo readout, released on April 30, that called for coordinated measures to digest existing housing stock. A few models have been proposed, all of which essentially involve the government buying apartments from homeowners who are looking to upgrade, or from troubled developers.

Has the market raced ahead of reality? China is vague on how the 1 trillion yuan will be used. President Xi Jinping’s new slogans, such as “new productive forces,” were mentioned, which seem to suggest that housing — a legacy business — will not be a main beneficiary. But then the government also highlighted the need to stimulate “still-weak domestic demand,” a rare admission from top policymakers, who have been more focused on the supply side. Those may be code words for helping the real-estate industry, giving some legitimacy to traders’ speculations. A majority of Chinese wealth is tied to property, which is in the third year of an unprecedented downturn.

And then there’s the question of who will end up holding these ultra-long bonds. Commercial banks own about 65% of China’s sovereign notes, with roughly half coming from the six biggest state-owned lenders, according to Bloomberg Intelligence estimates. However, since China plans to sell these notes via a public auction in the interbank market, small regional lenders will likely be jostling for a piece of the pie.

China’s treasury bond market has been on a tear, especially on the ultra-long end. The 30-year is yielding 50 basis points less than a year ago. Smaller lenders, flush with deposits and short on investment opportunities, have been piling in, igniting regulatory concerns that they are speculating on the securities and exposing themselves to potential duration risk.

Will this whale-sized auction sow the seeds for China’s version of the Silicon Valley Bank debacle? SVB Financial Group’s failure in 2023 offers a cautionary tale. The US lender had pumped billions of dollars into long-term Treasuries on expectations that rates would remain steady — only to see its massive wager fall apart as the Federal Reserve embarked on a steep hiking cycle. While not as volatile as the US, China’s Treasury market also has episodes of sell-offs.

That China is willing to tap into a special tool in order to stimulate growth is an encouraging sign. It might just remind global investors that Beijing has a track record of shock-and-awe interventions. Whether the government can pull off another one will depend on how exactly it executes and utilizes this bond sale.

Courtesy Bloomberg/Shuli Ren