Chinese ultra-long bonds are growing into dangerous bubble

Chinese ultra-long bonds are all the rage among investors, so much so that the country's central bank is starting to get uncomfortable about it.

A special auction of 50-year government notes reportedly attracted five times more demand than was anticipated, with bonds worth 35 billion yuan ($4.8 billion) sold.

The bond currently has a yield of 2.53%, less than analysts had anticipated, marking a fresh record low for the nation's longest-dated debt.

Frenzied activity has even prompted state media outlets to warn that the bond rally is unsustainable, and investors should be more sensible with their purchases.

Overall, the Chinese government will issue 1 trillion yuan (or $138 billion) worth of 50-year bonds.

This isn't the first time China's ultra-long bonds have proven so popular. A recent auction saw the price of 30-year notes surge by up to 25%, which meant trading had to be suspended.

At the time, one state banker in Shanghai told the Reuters news agency that bonds up for sale were "gone in seconds," with retail investors lining up outside branches before opening time.

Meanwhile, a bond brokerage trader in the city likened the situation to an "asset famine"—arguing there's not much else for financial institutions to snap up right now.

In a way, the heightened demand is good news and bad news for the People's Bank of China.

On one hand, the government can borrow for the long term pretty inexpensively, and invest at a time when certain parts of the economy are in distress.

But if the bond bubble bursts, this could plunge Chinese markets into jeopardy and hamper an economic recovery.

Love for long bonds

In recent analysis, Fidelity International sought to explain why Chinese investors are so passionate about ultra-long bonds, with demand now hitting a record high.

While once "one of the dullest securities in China's debt market," it's now been touted as a hot trade.

"The property market (traditionally the asset class of choice for Chinese investors) is yet to stabilize, the stock market remains volatile, and cross-border capital restrictions stop domestic investors from looking elsewhere for better returns," authors wrote.

A few other factors are worth bearing in mind, too.

With the government resisting the urge to inject economic stimulus on a large scale, many anticipate that China's recovery isn't going to happen overnight.

And given the PBoC is facing increasing pressure to cut interest rates, much like the Federal Reserve, investors are hoping to lock in higher yields while they can.

ING's chief economist in Greater China, Lynn Song, says "economic data developments" mean Beijing may end up moving first.

"We expect two rate cuts of 10bp each before the end of the year, though this could come in the form of one larger rate cut as well, depending on policymakers' priorities," he wrote.