The financial shifts across the world has affected China's bond market, with the threat of further slump, as prices for government and corporate bonds dropped last week and continued until Tuesday, Dec. 20, forcing the government to limit some trading and extend emergency loans to distressed financial institutions.
The New York Times said that the drop in bond prices has led to higher borrowing costs for many Chinese companies that needed the cash to cope with the slowing economy.
The report, however, said that yields peaked to new highs again on Tuesday, Dec. 20.
Aside from China's reaction to the global financial shifts, other factors may have contributed to the situation. This include Federal Reserve's raising of short-term interest rates and the expectation of heavy spending by U.S. government as Donald Trump assumes the presidency, which led investors to sell bonds worldwide.
On China's side, the slump may have resulted from government efforts to press out money from the financial system and prevent potential bubbles.
The report said that the bonds may drop further if the said efforts continue.
"The adjustment has not yet finished," Miao Zuoxing, a partner at the FXM Brothers Fund, that trades stocks, bonds and futures, said. "It will continue and normalize until money is put where the government can see it."
According to the report, at least 40 companies have announced that they would postpone or cancel their bond offerings rather than risk paying high interest rates to sell bond or not being able to sell them at all.
One of these companies, the Jiangsu Sumec Group Corporation, a trading house that exports items such as gardening tools and auto parts, said that it would cancel the sale of $130 million in short-term bonds.
"Due to recent, relatively large market fluctuations, our company decided to cancel the issue of the current bond," Jiangsu Sumec Group said in a statement, "and will reissue it at a chosen time."
China is concerned about the higher interest rates which could drive more Chinese investors to take their money out of the country to seek higher gains or avoid the country's financial problems.
Eswar S. Prasad, a professor of trade policy at Cornell University and formerly chief of the China division at the International Monetary Fund, said that the capital flight is "adding to domestic banking system stresses and weakening the already fragile foundations of the entire financial system".
The country's restructuring plans hinge on a strong bond market and China is counting on the fast-growing bond market to bring order to its economy.
State-run banks, which are the main source of funding in China, have fuelled the country's economic rise but also provided loans to its political allies and not to sectors that needed the fund. This led to surplus in some products, more than what is needed.
In recent months, local governments and other borrowers issued bonds at low interest rates to pay off bank loans. In the first 11 months of this year, the bond issuance increased by 47 percent.
But the government did not anticipate that Chinese banks would engage in speculative trading and raised money by selling wealth management products. Banks do not usually disclose information about their wealth management products.
But most of these products are backed by bonds. In June, the bond holdings of wealth management products have more than doubled in the last 18 months, the report said. The banks also started making bets on the direction of bond prices.
In a move to manage this, a central bank official said on Monday, Dec. 19, that China's central bank would start including wealth management products in their reviews next year, The Financial News, a newspaper of the central bank, reported.
On Tuesday, Dec. 20, the yield on government bonds jumped to 3.11 percent. When bond prices drop, yields rise, which means a higher yield would make it more expensive to issue bonds.
Meanwhile, corporate bonds are also rising, as investors ask for a return of their investment from companies.
Miao, a partner at FXM Brothers, believed that the sell-off of corporate bonds would continue until the gap between government corporate yields was wider again.
"When the corporate bubble has burst," Miao noted, "then we could say the adjustment is finished."