(P1) The People's Bank of China is signaling a potential end to the ultra-loose liquidity conditions that have fueled a dual rally in the nation's stock and bond markets, after a key gauge of financial leverage crossed a critical red line. An analysis from Huachuang Securities warns that the bond market leverage ratio has exceeded a 90% threshold that has historically preceded policy tightening, suggesting a major liquidity inflection point is approaching.
(P2) "'We believe that the beyond-expectation liquidity easing since March-April 2026 has entered an important observation window, and a liquidity turning point is getting closer," Zhang Yu, an analyst at Huachuang Securities, said in a recent note. "'The market needs to be more vigilant about the increased volatility brought by a marginal return to equilibrium."
(P3) The warning is supported by a bond market leverage ratio that has climbed into the 90th percentile, a level historically triggering a central bank response. Concurrently, the PBoC has begun a marginal policy shift. The central bank has conducted net fund withdrawals through open market operations since March and scaled back its Medium-term Lending Facility (MLF) in April. Furthermore, its first-quarter monetary policy report notably omitted previous mentions of potential cuts to interest rates and the reserve requirement ratio (RRR).
(P4) At stake is the durability of the recent "'dual bull"' market, which was driven by a rare combination of official liquidity from the PBoC and a surge of retail investor cash moving out of bank deposits. A move by the central bank to curb leverage and prevent financial asset bubbles could drain liquidity from the system, potentially halting the rally and introducing significant volatility for both domestic and global investors exposed to Chinese assets.
From Dual Bulls to a Tapering Trickle
The first half of 2026 saw a powerful rally in both Chinese stocks and bonds, a phenomenon fueled by what Zhang termed a "'dual liquidity resonance."' This contrasted with the sentiment in early 2023, when foreign investors were the primary drivers. According to China Daily, net northbound capital inflows via the Stock Connect program reached $23 billion in just the first few months of 2023, exceeding the total for all of 2022 and reflecting strong overseas optimism in China's post-pandemic recovery.
This year, the dynamic shifted as domestic retail investors, in a massive "'deposit relocation,"' moved savings into wealth management products, amplifying the PBoC's already accommodative stance. The result was a market where both government bonds and equities rallied in unison. However, the signs of a policy pivot are now clear, as the central bank prioritizes financial stability over fueling further asset price inflation.
The 90% Red Line
The core of the warning from Huachuang Securities lies in the bond market leverage ratio, a measure of financial institutions' borrowing to invest in bonds. When this ratio's 20-day average surpasses the 90th percentile, it indicates that leveraged carry trades are becoming excessive, a condition the PBoC has consistently acted to curtail.
History provides a clear guide to the central bank's reaction function.
- 2016: After the ratio crossed 90%, the PBoC tightened policy and launched macroprudential assessments.
- 2020: A spike in April driven by pandemic-relief liquidity was met with a swift suspension of reverse repo operations.
- 2022: A surge in leverage following concentrated fiscal stimulus in the summer was followed by a liquidity turning point in September.
- 2023: The ratio again breached the 90% mark in August amid rate cuts, prompting the PBoC to explicitly warn against "'funds circulating idly and arbitrage."'
Each time, the crossing of this threshold led to a liquidity inflection point. With the market once again at this critical juncture, the probability of further easing is low. Investors will now be closely watching for a definitive confirmation signal: a shift from negative to positive net financing in interbank certificates of deposit, which would prove the banking system is no longer flush with excess cash.
This domestic focus on leverage and financial stability puts the PBoC on a divergent path from its Western counterparts. While central banks like the U.S. Federal Reserve and the European Central Bank remain preoccupied with taming inflation driven by geopolitical energy shocks, as detailed in a recent Forbes analysis, the PBoC is shifting its focus inward to manage the consequences of its own stimulus measures.
This article is for informational purposes only and does not constitute investment advice.
