Leverage, counterparty risks and maturity mismatch. China’s record bull run in bonds had all the signs of a bubble in the making. When expectations for faster US rate increases added to pressure from rising funding costs in China, the correction in the debt market, which started in October, turned into a rout. Bond futures plunged by a record last week, the 10-year yield surged by the most in two years and interest-rate swaps reached a 20-month high. The selloff has sparked a chain reaction among banks, funds and brokerages as losses spread. According to Bloomberg, much of the risk stems from a strategy favored by investment firms managing bank wealth products, which involves the borrowing of short-term funds to invest in debt. The rout has exposed the vulnerabilities of a market that had built a leverage chain entirely dependent on loose funding.
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