CHINA’S sovereign bonds posted the biggest weekly decline in two years last week, reeling from the fallout of hawkish Federal Reserve comments, yuan depreciation pressures and waning liquidity.

    The 10-year sovereign yield surged 25 basis points last week, the most since December 2014, to 3.35 percent Friday. The one-year yield jumped 50 basis points, while the five-year rose 27 basis points. The yuan hit fresh 8-1/2 year lows Friday, with expectations for further depreciation rising after the U.S. Federal Reserve increased interest rates Wednesday.

    The debt market selloff caught investors by surprise, with BoCom International Holdings Co. flagging the risk of further declines and Commonwealth Bank of Australia saying it’s hard to see a reversal of fortunes even in the mid-term. While the Fed’s indications of quicker tightening fueled fears of faster fund outflows and ignited a record one-day yield jump Thursday, Chinese bonds have been under pressure in recent weeks from a government-driven effort to reduce leverage.

    “Given capital outflows, the overall liquidity in the domestic market is volatile,” said Kun Shan, head of local market strategy in China at BNP Paribas SA in Shanghai. “It depends on how the central bank will manage this, but the overall trend won’t change dramatically because we’re near year-end and it really depends on yuan depreciation.”

    Policymakers shifted their focus in the second half of this year to reducing financial risks as economic growth stabilized, with Yi Gang, deputy governor of the People’s Bank of China, saying in early September the nation’s short-term goal is to lower leverage ratio growth.

    By steering money market rates higher, the People’s Bank of China has forced a correction in the highly leveraged bond market, while home prices are showing signs of cooling amid property curbs.

    While the central bank has been using new lending tools and open market operations to replenish liquidity, they haven’t been enough to offset persistent cash outflows. In the eight months through November, the outstanding balance in the monetary authority’s Medium-term Lending Facility increased by 1.4 trillion yuan (US$201 billion), while the central bank’s yuan positions, a gauge of capital flows, dropped by 1.6 trillion yuan. The nation’s foreign exchange reserves fell by US$69.1 billion in November, the most since January.

    The Ministry of Finance sold only 9.57 billion yuan in 182-day bills in a planned 10 billion yuan sale Friday. (SD-Agencies)