Amid ongoing uncertainty surrounding the People’s Bank of China (PBOC) and its potential intervention in the bond market, traders are increasingly turning to a less-traded segment of the yield curve—the seven-year government bonds. This move aims to capitalize on anticipated interest rate cuts while avoiding the heightened scrutiny and potential intervention affecting longer-term debt.
This week, yields on seven-year government bonds fell below 2% for the first time ever, a decline that surpasses those in other major bond maturities. This drop signals a shift toward the so-called “belly” of the yield curve—an area traditionally less favored by traders but now gaining attention as authorities work to control rises in longer-dated securities.
Carol Lye, a portfolio manager at Brandywine Global Investment Management, described this trend as a strategic refuge. “The belly benefits from the rate cuts and yet it’s not in the bucket where the PBOC is trying to control the long-end of the curve,” she said.
China’s bond market has witnessed a series of record lows in yields as investors seek safety amid economic strains from a property crisis and sluggish demand. Policymakers have responded by cutting interest rates and committing to further support economic growth by reducing funding costs.
However, the bond rally carries a notable risk: the possibility of intervention by the PBOC. There are growing concerns that the central bank might act to curb the record-low yields to prevent a potential bubble in the bond market, particularly targeting long-term bonds.
Analysts suggest that any intervention would likely be focused on long-term notes, leading traders to favor the less crowded seven-year segment of the curve. In July, transactions in five- to seven-year bonds amounted to approximately 1.6 trillion yuan ($214 billion), representing only a fraction of the trading volume of seven- to ten-year bonds.
Yingrui Wang, a China economist at AXA Investment Managers, noted that investors might increasingly look at intermediate tenors like the seven-year bonds as a way to balance yield and risk, especially if the PBOC intensifies its efforts in the long-end segment. “The spread between seven- and ten-year bonds could widen,” Wang added.
As of Thursday, the yield on seven-year bonds had dropped to 1.96%, reflecting a decline of seven basis points over the week. Meanwhile, the yield on ten-year bonds remained at a record low of 2.12%.
According to Andrea Yang, China macro strategist at JPMorgan Asset Management, any tightening of liquidity in August could further enhance the appeal of the seven-year bonds compared to shorter-term securities. “July saw significant liquidity injections into China’s money market,” she said.
While investing in seven-year bonds presents opportunities, it is not without risks. Potential challenges include less-than-expected PBOC easing or unforeseen interventions. Nonetheless, trading activity in this segment has surged, with transactions in July up 60% from the previous year.
Yang concluded, “We find the belly of the curve a more attractive opportunity for now. Our current strategy is to maintain our position unless we see substantial stimulus measures, which seem unlikely.”
