Bond leverage in China is unravelling at both ends: the interest rates on funds used for carry-trade speculation are going up, the prices of the bonds subject to such speculation are going down. From bloomberg.news:
Investors get squeezed as bond prices fall, repo rates rise
“It looks like everybody is cutting their leverage”
After years of racking up profits by borrowing cheaply and plowing the proceeds into higher-yielding debt, investors are now rushing to unwind those wagers amid the deepest selloff in 13 months. The bets are getting squeezed from both sides as bond prices sink and borrowing costs rise to one-year highs in the 8 trillion yuan ($1.2 trillion) market for repurchase agreements, used by traders to amplify their buying power.
While a reduction in leveraged wagers is arguably good for China’s long-term financial stability, it risks fueling a downward spiral in a market that Pacific Investment Management Co. says already shows signs of panic amid mounting default concerns. The pullback challenges government efforts to revive economic growth with cheap credit and could hardly come at a worse time for Chinese companies on the hook for a record 547 billion yuan of maturing onshore notes in May.
“It looks like everybody is cutting their leverage, passively or pro-actively, as pessimistic sentiment continues to brew,” said Wang Ming, chief operating officer at Shanghai Yaozhi Asset Management LLP, which oversees 15 billion yuan of fixed-income securities. “Carry trades have become riskier.”
Overnight Rates
Outstanding positions in the repo market — where investors can pledge existing bond holdings for cash to invest in more debt — have dropped by 18 percent this year through March, reversing a three-year climb to all-time highs in December. While it’s unclear how many of those transactions were used to buy more bonds, analysts at Haitong Securities Co. and Minsheng Securities Co. both say repos are the best available proxy for leverage in China’s debt market.
It’s getting more expensive for investors to lever up as market volatility makes lenders more cautious and forecasters push back estimates for another central bank interest-rate cut to at least the fourth quarter. The cost of overnight repos has averaged 1.99 percent this month, up from 1.14 percent in June.
“There is still plenty of room for rates to go higher,” Zhou Hao, an economist at Commerzbank AG, wrote in a report on Wednesday.
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