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China money rates end week at highest level since June cash crunch

Pete Sweeney
Friday, 25 Oct 2013 | 1:43 AM ET

* Short-term rates at highest level since June credit crunch

* Banks decline to inject cash despite rising demand

* Economists debate whether structural tightening under way

* Benchmark average 7-day repo at nearly 5 pct

SHANGHAI, Oct 25 (Reuters) - China's money rates shot up this week to their highest levels since June's dramatic cash crunch as regulators signalled they are considering mild tightening to get rising property prices and inflation under control. The most commonly traded bond repurchase contracts showed spikes in quoted rates on Thursday and Friday after the central bank abstained from injecting cash for the third consecutive session, resulting in a net drain and alarming some traders. For example, the overnight repo rate was quoted at 7.5 percent at one point, its highest level since June 28. The benchmark seven-day repo hit 6.94 percent on Thursday while the 14-day repo hit 6.6 percent the same day. Volume-weighted average prices (VWAP) which reflect transaction sizes were lower, ranging between 4.47 percent and 5.89 percent, but also at their highest point since June. Traders said the spike trades were outlying quotes from a few small overextended banks, but average rates also posted triple digit basis-point rises, illustrating the change in sentiment. "Today sentiment is pretty nervous, just like yesterday. I think the high rates are mostly due to a psychological reaction," said a dealer at a major state-owned bank in Beijing. "One reason is the central bank stopping issuance of reverse repos during open market operations (which inject cash). And then there are the tax payments coming due." Rates had previously been steadily declining since the beginning of the month thanks to easy liquidity, which traders attributed mostly to foreign capital inflows and central bank interventions in the forex market. Money rates, however, remained far below the stratospheric levels during the June cash crunch, which set off a panic in financial markets globally. The squeeze saw some intraday quotes for short-term instruments coming in as high as 30 percent. The seven-day repo VWAP rose to over 11 percent on June 20. However, the present situation shares some similarities. Once again, the People's Bank of China (PBOC) has held off from fully satisfying cash demand to make month-end tax and regulatory escrow payments, which has put upward pressure on rates. In fact, whereas in June the PBOC injected a small amount of funds, this time the central bank has held off from injecting any funds at all for the last three sessions, resulting in a net drain of 58 billion yuan for the week. The central bank has drained a net 157.5 billion yuan from markets since Sept. 30. Traders are keeping a close eye on what the bank does next week, when maturing central bank bills will drain a net 6 billion ($986.27 million) yuan, a relatively small amount.

TIGHTENING OR NOT? Economists are divided on the significance of this week's phenomenon, with some arguing that it marks a first step toward making cash more expensive over the long term, following years of easy money in the aftermath of the global financial crisis. "We do not believe that the current rise in the repo rate is being driven by seasonal factors such as the corporate tax payment season," wrote Zhang Zhiwei, economist with Nomura, in a research note. "The Chinese government is well aware of such seasonal factors and could have adjusted its liquidity management accordingly to offset such factors and avoid rise of the repo rate, yet it has allowed repo rates to rise, which we take as a clear policy signal." However, others argued this was merely a seasonal tweak and that conditions would quickly return to normal. Steve Wang and David Goldman of Reorient Financial Markets Ltd pointed out that so far the net basis point rise in the seven-day repo rate was roughly in line with month-end rises in previous months this year. However, neither traders nor economists who spoke to Reuters predicted a return to the extraordinarily tight conditions in June, which saw domestic media reporting ATMs running out of cash as banks ran dry. The market is also debating how liquidity will be tightened. Regulators have said they are going to make adjustments to get credit growth and inflation under control, but few expect a massive structural adjustment like an increase to reserve requirement ratios (RRR) at banks, which would withdraw base money supply from the economy for a long period of time. This could mean that the central bank will continue to rely on a combination of short-term interventions in the interbank market, but perhaps shift back to issuing short-term forward repos, which drain cash for short periods from a seven to 91 days. Alternatively, some economists believe Beijing has room to implement a mild rise in interest rates, given some signs of economic recovery, in particular after a strong manufacturing survey released on Thursday.

SHORT TERM RATES:

Instrument RIC Rate* Change (weekly,

bps)**

1-day repo CN1DRP=CFXS 4.47 121.78 7-day repo CN7DRP=CFXS 4.98 129.49 14-day repo CN14DRP=CFXS 5.89 131.87 7-day SHIBOR SHICNYSWD= 4.68 119.5

*The volume-weighted average price (Vwap) at midday Friday

** Compared to the Vwap at market close the previous Friday

KEY INTEREST RATE SWAPS:

Instrument RIC Rate Spread (bps)* 2 yr IRS based on 1 year CNABAD2YF= 2.9192 8

benchmark

5 yr 7-day repo swap CNYQB7R5Y= 4.17 -117 1 yr 7-day repo swap CNYQB7R1Y= 4.17 -117

*This spread can be seen as a proxy for forward-looking market expectations of an interest rate cut or rise.

GOVERNMENT BOND FUTURES

Instrument RIC Rate Change

(weekly, bps)

Dec 2013 5 yr CTFZ3 93.78 -18.79 Mar 2014 5 yr CTFH4 93.91 -13.40 Jun 2014 5 yr CTFM4 94.03 -8.98

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MARKET DRIVERS - Govt bond futures market to start with a whimper, not a bang - In wake of cash crunch, PBOC commits to transparency but quietly tightens grip - CHINA MONEY-Tighter interbank regulation seen after cash squeeze - Collapse in China bond volumes exposes market's seamy side

DATA POINTS - External liquidity tracker: Rise in fiscal deposits slams liquidity in July http://link.reuters.com/pem75t - Impact of maturing central bank bills and repos GRAPHIC: http://link.reuters.com/pem75t - Chinese government bond curve steepens as growth fears ease GRAPHIC: http://link.reuters.com/jyr95t - China's interest-rate swap curve steepens as growth prospects improve GRAPHIC: http://link.reuters.com/ryr95t - China corporate bond spreads narrowed on improving growth outlook GRAPHIC: http://link.reuters.com/bas95t - Hot money tracker: Hot money outflows reached record high in July GRAPHIC: http://link.reuters.com/saz74t

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(Additional reporting by Chen Yixin; Editing by Jacqueline Wong)