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China money rates correct to end lower after volatile week

Lu Jianxin and Pete Sweeney
Friday, 1 Nov 2013 | 1:54 AM ET

* Midweek short-term rates hit highest level since June

* C.bank injection helps soothe market sentiment

* Liquidity conditions expected to improve next 2 months

* PBOC may reverse tactics, begin draining cash

SHANGHAI, Nov 1 (Reuters) - China's money rates trended lower this week after roller-coaster trading, driven by cash demand for corporate tax payments coming due, and the need for banks to meet regulatory requirements such as loan-to-deposit ratios. After sitting on the sidelines the previous week, the People's Bank of China (PBOC) came to the market's rescue this week, injecting money via weekly open market operations on Tuesday and Thursday, ending up the week with a net injection of 29.1 billion yuan ($4.77 billion). With more supply on the way to the market, traders expect money rates to fall further in coming weeks, and if liquidity proves to be abundant, the PBOC may shift operations to forwards repos to drain cash instead of using reverse repos to inject money as it has done since August, traders said. "The PBOC's injection this week was small and not enough to cover seasonal cash demand, which pushed short-term funding costs up sharply around the mid-week," said a trader at a Chinese commercial bank in Shanghai. "It nevertheless exerted a psychological impact on the market, reassuring traders that regulators will come to the market's rescue in case of extreme need," she said. "With banks more willing to lend after the PBOC injection, money rates started slumping on Thursday and are set to end the week lower than the end of last week." For example, the volume-weighted average price (VWAP) of the overnight repo was quoted at 5.30 percent at the close on Wednesday, its highest closing level since the domestic market's cash squeeze in June. But it fell to 4.29 percent at midday on Friday, heading for a fall around 26 basis points this week compared with last week's close of 4.55 percent. The VWAP of the benchmark seven-day repo hit its highest closing high of 5.69 percent since June also on Wednesday, but dropped to 4.61 percent at Friday's midday, set to stage a slump of 45 bps from last week's 5.06 percent. Money market rates had jumped as corporates typically pay third-quarter income tax in late October and by end-month demand, aggravated by speculation that regulators may tighten monetary policy after recent official data pointing to higher-than-expected inflation and housing price growth, traders said. Rare volatility seen in the rates this week, the severest since June, has also indicated that the market's ability to handle seasonal demand has been weakened by the PBOC favouring a tight liquidity policy for most of the year amid official worries over red-hot property prices. 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. Traders said money supply will be greatly improved in November and December, the two months when the Ministry of Finance pumps large amounts of money into the markets -- redistributing tax revenues. Last year, the ministry injected 114.9 billion yuan into the banking system in November and 1.17 trillion yuan in December.

SHORT TERM RATES:

Instrument RIC Rate* Change (weekly,

bps)**

1-day repo CN1DRP=CFXS 4.2919 -25.65 7-day repo CN7DRP=CFXS 4.6125 -44.99 14-day repo CN14DRP=CFXS 5.0285 -86.91 7-day SHIBOR SHICNYSWD= 4.6100 -28.10 *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= 2.9522 -4.78

benchmark

5 yr 7-day repo swap CNYQB7R5Y= 4.31 +131 1 yr 7-day repo swap CNYQB7R1Y= 4.12 +112 *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 93.798 +16.8 Mar 2014 5 yr CTFH4 93.798 +22.8 Jun 2014 5 yr CTFM4 93.954 +15.6

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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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(Editing by Eric Meijer)