Chinese ten-year treasury futures for December delivery sold off on Monday by the most since August, as investors took profits after a sharp run-up in government debt and traders eyed tighter liquidity as a result of suspected currency market intervention to support the yuan
"There's expectation that the government will switch to a tighter monetary policy, because otherwise, domestic asset price bubbles will get bigger, and there will be increasing depreciation pressure," Xia said
Xia said that liquidity supply growth exceeding that of the economy would hurt the value of the Chinese currency, either externally, or internally.
As China's currency hit a six year low against the dollar Monday, three currency traders told Reuters that state banks, suspected of acting at the behest of the central bank, sold dollars to stem the decline. Large dollar sales in exchange for yuan tend to tighten yuan liquidity.
The ten-year future for December delivery was down 0.32 percent from last Friday's closing price by late afternoon, in the sharpest fall since late summer. Prices in the spot market also sold off, with 10-year treasury yields rising four basis points (bps) to 2.70 percent.
Chinese government debt has enjoyed a remarkable run since mid-June, which has pushed yields on the benchmark ten-year treasury bond down 30 bps during that period.
Analysts say low global yields paired with regulators' decision to open up the domestic interbank bond market to all medium and long-term investors in February has helped draw in substantial foreign capital.
Some observers say the yuan's official inclusion in the International Monetary Fund's synthetic reserve currency, Special Drawing Rights, has also played a role.
"As the RMB enters the IMF's special drawing rights (SDR) basket this month, more adjustments are being made to smooth access to Chinese credit for global institutions," wrote analysts at Shanghai based Z-Ben Advisors in a Monday note.
"Incremental changes are having the desired effect and September alone saw USD11bn flow into government and policy bank bonds - likely from global central banks beginning the transition to RMB-denominated holdings."
The run-up in government debt pushed the benchmark ten-year treasury near multi-year lows touched in August, but Monday's sell-off may suggest that government debt prices will have trouble climbing much further.
A tax deadline on Moday could also have been an additional factor behind the tighter money market liquidity. Traders say demand for cash has increased in recent days from corporations preparing to meet the third quarter tax pavement deadline