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China govt bond futures hit record lows amid tightening worries

Lu Jianxin and Gabriel Wildau
Friday, 8 Nov 2013 | 12:32 AM ET

* Govt bond futures drop sharply

* Money rates down for the week but remain elevated

* C.bank suspends cash injections into money markets

* C.bank may drain cash to offset foreign capital inflows

SHANGHAI, Nov 8 (Reuters) - China's government bond futures contracts hit record lows this week, while short-term lending rates remained at relatively high levels, as markets responded to signs the central bank may start draining cash soon. The People's Bank of China declined to inject liquidity into the money markets at regular open market operations on Thursday, triggering widespread worries that it would start a new round of tightening in the coming months, traders said. The PBOC appears to be preparing to reverse its liquidity management strategy due to expectations of large capital flows into China, traders said. The central bank may drain short-term cash from the markets via repos to offset the impact of capital inflows and suppress resurgent inflation and home price growth.

"Investors have turned quite nervous about how the central bank is going to manage liquidity in coming months," said a trader at an Asian bank in Shanghai. "But with futures prices now hitting bottom and money market rates staying at relatively high levels, the potential for them to move further will be limited." The benchmark December 2013 five-year contract dropped as low as 91.718 yuan ($15) on Friday morning, its lowest level since China relaunched trading of government bond futures in early September following an 18-year ban. It trimmed some losses to stand at 92.45 yuan at midday, but was still down from 93.806 at the end of last week. The March 2014 contract also hit a record low of 92.364 yuan on Friday morning, so did the June 2014 contract at 93.206 yuan. All three contracts first tumbled to their all-time lows on Thursday after the PBOC halted injecting money via reverse repos in its open market operations. In the money markets, the volume-weighted average rate for the benchmark seven-day bond repurchase agreements dropped 66 basis points to 3.94 percent by midday on Friday from the close last Friday. Still, the rate stayed at the high end of the 3-4 percent range that the market sees as normal for borrowing and lending business in the money markets. The overnight repo rate fell 51 bps on the week to 3.77 percent while 14-day rate lost 50 bps to 4.62 percent. Despite fears of possible PBOC liquidity tightening, markets rates do not yet reflect expectations of an official interest rate hike. Two-year interest rate swaps (IRS) based on China's one-year benchmark bank deposit rate held at 2.96 percent by midday, 4 bps below the benchmark rate of 3 percent. That is partly an outcome of the central bank's improved communications with the market since a market cash squeeze in June, traders said. As part of a crackdown on banks engaged in riskier lending, the PBOC engineered a cash crunch in late June during which the seven-day repo rate skyrocketed to as high as 30 percent, rattling financial markets globally and inciting criticism of the PBOC for failing to communicate its intentions.

During a less severe cash crunch in late October, however, the PBOC convened a meeting with banks to tell them the situation, while injecting short-term money via open market operations to smooth urgent demand. The central bank has also begun publishing data on a recently-launched liquidity management tool, the Short-term Lending Facility (SLF), modelled after the U.S. Federal Reserve's discount window, in another step towards improving transparency.

SHORT TERM RATES:

Instrument RIC Rate* Change (weekly,

bps)**

1-day repo CN1DRP=CFXS 3.7670 -51.28 7-day repo CN7DRP=CFXS 3.9428 -65.68 14-day repo CN14DRP=CFXS 4.6156 -50.47 7-day SHIBOR SHICNYSWD= 3.9390 -67.10 *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= 2.9592 -4.08

benchmark

5 yr 7-day repo swap CNYQB7R5Y= 4.65 +165 1 yr 7-day repo swap CNYQB7R1Y= 4.34 +134 *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 Price Change

(weekly, pct)

Dec 2013 5 yr CTFZ3 92.450 -1.45 Mar 2014 5 yr CTFH4 92.916 -1.16 Jun 2014 5 yr CTFM4 93.422 -0.73 >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>

MARKET DRIVERS - CHINA MONEY-PBOC hopes to drain sloppy money without raising primary rates as growth revives - 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 Simon Cameron-Moore)