China's treasury futures activity gauge points to divided policy outlook

A gauge of activity in China's financial futures market hit an all-time high this week as investors placed bets on the prospects for imminent policy easing to arrest a slowdown in the world's second-largest economy. Signalling disagreement over policy direction, some market players warn that it could foreshadow a surge in market volatility if investors close their positions in a hurry.

Open interest in China's benchmark 10-year treasury futures, the total number of open long and short contracts, hit an all-time high of 93,514 lots on Thursday. The most-traded contract, for December delivery, set a record of 86,990 lots. Open contracts for two-year and five-year treasury futures showed a similar upward trend.

The surge reflected very different views of the market, Ji Tianhe, China head of foreign exchange and local markets strategy at BNP Paribas said. "It's really a confrontation at the moment. Investors who hold long positions are not liquidating (and) those who have lost money are waiting for a turnaround. Each side believes in its argument firmly and thinks the other side is wrong," Ji said.

The rising disagreement follows the release of higher consumer inflation figures that forced the central bank to unexpectedly keep its new lending benchmark steady this month for the first time since its debut. That move suggested Beijing is keen to avoid loosening monetary policy too much lest it push up already-high debt levels across the economy. China's consumer prices rose 3% in September from a year earlier, rising at their fastest pace in almost six years, driven mostly by a surge in pork prices as African swine fever ravages the country's hog herds.

Demand for both hedging and speculation spiked following the data, which traders and analysts said could prompt a change in China's near-term policy stance. Many analysts expect inflation to remain elevated through the first quarter of next year. "Given inflation pressure remains huge and Consumer Price Index's (CPI) nominal growth is expected to rise further, market participants are getting more cautious," said Dong Dezhi, analyst at Guoxin Securities.

"Some investors hedged against bond risks in their portfolio, while some others have chosen to directly short treasury futures." Yields on China's benchmark 10-year government bonds have risen about 10 basis points so far this month to 3.25%. However, while inflation data cautions against easing, a slew of downbeat economic growth figures and the Sino-US trade dispute continue to suggest that more stimulus is needed. China's economy grew a slower-than-expected 6% in the third quarter, its weakest pace in nearly three decades.

Liu Changjiang, macro strategist at AVIC Trust, said bond bears expect economic condition to stabilise in the fourth quarter, while bulls doubt that China will escape a global economic downturn. "Investors from both sides have been loading up on their positions, similar to gambling ... When we see the result, those betting on the wrong side will close their positions, pushing up trading volume and dragging open interest lower," Liu said. Traders warned that the bond market could wrong-foot investors once it picks a clear direction. "It's very possible that we could see a spike in stop-loss orders, which could lead to huge volatility," said Dong at Guoxin Securities.