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Markets


CHINA STARTS TO PULL CASH IN PIVOT FROM CRISIS POLICY EASING

 * China’s 1-year interest rate swap rises to highest since March
 * PBOC move follows manufacturing activity expansion in May

Bloomberg News
July 6, 2022 at 7:53 AM GMTUpdated onJuly 7, 2022 at 3:10 AM GMT


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China’s central bank looks set to withdraw cash from the financial system in a
sign that it’s moving toward normalizing monetary policy as major global peers
are forcefully raising interest rates.

The People’s Bank of China slashed its daily short-term liquidity operation to 3
billion yuan ($447 million) this week, the smallest amount since January 2021.
At this pace the central bank removed more cash in the first five sessions of
this month than it injected toward end-June.




“The PBOC is shifting its monetary policy from a crisis mode to a
normalization,” Ming Ming, chief economist at Citic Securities, wrote in a note.
The central bank tolerated the low money market rate levels in the second
quarter when Covid outbreaks disturbed economic growth, but that might be coming
to an end, he wrote.

The shift in PBOC’s liquidity stance has already pushed up bonds yields and
threatens to lift money-market rates that have anchored China’s wide-ranging
efforts to restore its Covid-hit economy. Analysts now see tighter financial
conditions in the second half of the year as the central bank removes more cash
while credit demand should pick up as data last week showed the first expansion
in manufacturing activity in three months.


 
 

The PBOC is among the few major central banks that’s still on an easing track as
China’s Covid zero policy acts as a drag on the economy. It added cash to the
banking system in the first half of the year via tools including the medium-term
lending facility, a reduction in the reserve requirement ratio as well as by
transferring its profits to the government.




Despite the recent cash drain the overnight repo rate, a measure of interbank
borrowing costs, dropped to 1.2% this week, the lowest since Jan. 28,
highlighting the extent of excess liquidity in the banking system. Zhang
Jingjing, an analyst at China Merchants Securities said the PBOC may try to
bring the overnight repo rate closer to its seven-day rate of 2.1%.

The smaller-than-expected open market roll-over may be the central bank’s
attempt to introduce volatility and reduce financial leveraging in the bond
market, Goldman Sachs Group Inc. strategists including Xinquan Chen wrote in a
note this week. Excessively low interest rates could also add to financial risks
via increasing arbitrage activity, where corporates may borrow funds for
redeposit rather than real investment, they wrote.



READ: PBOC Fires Warning Shot to Leveraged Bond Investors: China Today




The PBOC has drained a net 428 billion yuan ($64 billion) of cash in the first
five sessions this month through July 7, more than the 400 billion it net
injected before June end. 


FADING SUPPLY



The peaking out of Chinese local government bond issuance has also reduced the
urgency for the PBOC to keep funding rates low in July, said Chen Xi, an analyst
at Pacific Securities. Regional governments sold a record 4.04 trillion yuan
bonds in the first six months of the year, leaving only 330 million of the quota
for the remaining year, Bloomberg data show. The central bank may guide bond
market leverage lower and steer more cash to the real economy, Chen said.

The front-end of China’s sovereign bond curve is already pricing in tighter
cash. The yield on one-year China government bonds rose to 2.01% Tuesday, the
highest since June 17, while the one-year onshore interest rate swap touched
2.23% this week, the highest since March.

Today’s other Asia markets news:
 * ‘Bad for EM’: Why Funds Are Furiously Selling Risky Currencies
 * Bets RBI May Go Slow on Rate Hikes Spur Rally in Indian Bonds
 * Treasuries’ Biggest Fans Lose Reason to Back the Bond Rally
 * SenseTime Plunge Raises Stakes for Slew of China Lockup Lifts

Still, investor caution on the economy is reflected in the long end of the curve
where yields have eased over the risk of recurring Covid outbreaks. A jump in
infections across Shanghai has raised the specter of another lockdown. The
government bond yield curve may flatten with back-end sovereign bonds finding
more support as risks to economic recovery linger, Qin Han, analyst at Guotai
Junan Securities, wrote in a note.

The PBOC last week reiterated its pledge to provide stronger support for the
economy. Monetary policy may prioritize credit expansion over interest reduction
in the coming months, according to economists including Xiangrong Yu at
Citigroup Inc., who still expect a 25 basis points reduction in reserve
requirement ratio on a discretionary basis to facilitate fiscal and semi-fiscal
efforts.



— With assistance by Charlie Zhu, and Wenjin Lv

(Updates with latest open market operations in the second paragraph and the
eighth paragraph)




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