China Traders Borrow Trillions to Juice Returns in Bond Market

(Bloomberg) — China’s local traders are borrowing a record amount of short-term cash, in a sign they are leveraging up returns in a stable bond market.

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Turnover in so-called pledged repurchase trades surged past 8 trillion yuan ($1.2 trillion) to an all-time high Thursday, according to calculations by Bloomberg. The figures are used as a gauge of leveraged activity in bonds, even if the transactions also include the day-to-day financing needs of firms in the market.

The record comes amid falling borrowing costs after the People’s Bank of China cut lenders’ required reserve ratios in late March to support credit growth.

Lower funding costs after the cut lured traders to boost leverage, led by non-banking institutions such as securities companies and funds, said Zhaopeng Xing, a senior strategist at Australia & New Zealand Banking Group. Through borrowing at lower rates and buying higher yielding notes, this strategy would earn a profit even if yields on the bonds don’t decline, he said.

China’s 10-year yield has traded in a tight range this year, between 2.80% and 2.95%. The benchmark yield fell one basis point to 2.85% on Friday, on track for its lowest close since January.

The growth in leverage may cause a headache for officials who would rather the credit growth finds its way into the real economy. However, the PBOC is unlikely to actively clamp down on leverage at this stage, to avoid market volatility in a still-fragile economy, according to Xing.

(Updates with China bond gain Friday.)