Back to Reality: China Has a Trillion Dollar Bond Problem

Outstanding positions in the repo market has dropped by 18% this year, as Chinese bond traders scurry about like rats to unwind blockheaded high yield positions. With NPLs soaring by 50%, year over year, bond traders are facing immense pressure as the maturity wall looms.

“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.”

State-owned China Railway Materials has suspended their bond trading schemes, citing ‘repayment issues.’ This has the bond nerds over at PIMCO pondering the very existence of life.

“When you have a large SOE who suddenly suspends its bond trading, you think: ‘How many more are there?’” said Raja Mukherji, the Hong Kong-based head of Asian credit research at Pimco, which oversees about $1.5 trillion worldwide. “It kind of leads to a bit of panic in the onshore market. Investors are likely to want to look at their portfolio and sell some of the bonds.”

Despite signs of distress, bond traders don’t think their will be extensive carnage in the Chinese corporate bond markets–because the government won’t allow it to happen.

“We don’t think there will be a big correction in the corporate bond market unless continuous and large-scale defaults trigger a liquidity crisis in the financial system,” said Wei, a money manager at Bosera Asset Management Co. in Shenzhen. “The probability of such systemic risks is very low given regulators’ good care for the market.”

I’ll bottom line it for you. A weak corporate bond market is oppressive for liquidity, which in turn is bad for stocks. As NPLs rise in China, there need for capital is greater than ever. This, of course, could become a problem.

“The volatility in funding costs, coupled with exposing credit risks, are draining the liquidity in the bond market,” Sun said. “Given the market expectation of a neutral monetary policy stance, investors may continue to be forced to de-leverage.”

As you were. The Facebook earnings were great and oil has bottomed and China has bottomed and Europe is picking up steam.

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