All is not well in China and the interbank market in the country is sending baffling signals, according to First Global Chief Strategist Devina Mehra.
“Chinese interbank market sends baffling signals. After the high drama witnessed in Europe, the Chinese financial markets have been sending some seriously disturbing signals since the last fortnight” said Mehra in a research note on Thursday.
Following a 5.5 percent jump in inflation in May, Mehra believes there has been a significant increase in the short-term funding costs.
“As per data provided by the National Interbank Funding Centre, the 7-day government bond repurchase (or repo) rate rose to over 9 percent last Thursday, marking the highest level (barring October 26, 2007) at least since 2001 when the data became available,"
“As a result of the tight short-term funding market, the Chinese yield curve has flattened significantly at the short-end and has inverted at the long-end for the first time since late 2008," she said.
While the flat yield curve is, in Mehra’s view, undoubtedly a serious concern, she said the speed of the deterioration is ‘remarkable’
“Since January 2010, the Chinese authorities have raised the required reserve ratio and benchmark deposit and lending rates 12 times and 4 times respectively”
“These developments do not bode well for the Chinese financial markets. However, the Chinese government does not appear to be giving away any easy money and is focusing on inflation rather than growth, which is partly evident in the estimated annual average growth of 7 percent in the 12th Five Year Plan.
“It still remains to be seen whether the targeted growth can be achieved without much pain, as the Chinese economy has recorded a growth of 11.2 percent in the last five years, as against the estimated growth of 7.5 percent in the 11th Five Year Plan,” Mehra wrote.