WRAPUP 2-China's yuan, bonds temper rally as markets await clarity on trade, policy

Andrew Galbraith


* Onshore yuan at 6.9953 per dollar

* Government bond futures higher but market cautious -trader

* Equities retreat after three days of gains; SSEC -0.32%

SHANGHAI, Nov 6 (Reuters) - China's yuan gained and government debt futures ticked higher on Wednesday, a day after a surge of optimism around trade talks between China and the United States pushed the local currency to three-month highs and a medium-term rate cut boosted bonds.

The moves on the day, however, were restrained, suggesting that investors are waiting on further developments on trade talks, as well as more clarity on policy easing, analysts say.

The onshore spot yuan opened at 6.9967 per dollar and was trading at 6.9953 per dollar around 0530 GMT, stronger than Tuesday's late session close of 7.0058 per dollar. The yuan broke through the psychologically important 7-per dollar level to touch 6.9880 earlier on the previous day, its firmest level since Aug. 2.

The rise in the onshore yuan on Wednesday came after the People's Bank of China (PBOC) set its daily reference rate for the currency's trading band at 7.0080, its strongest level since Aug. 8.

The offshore yuan also strengthened from Tuesday's close, rising 0.07% to 6.9970 per dollar around 0530 GMT.

Ken Cheung, chief Asian FX strategist at Mizuho Bank in Hong Kong, said it remained to be seen how long the yuan would sustain its break through the 7-per-dollar level.

"In light of upbeat expectation for the phase one deal, the CNH and CNY will likely on and off trade below 7 handle, suggesting that the CNY of 7 level is no longer the key resistance level," he said in a note, adding that 6.98-per-dollar is a "more critical level to watch."

Chinese and global markets took on a risk-on tone this week on growing signs that Washington and Beijing were edging closer to sealing a preliminary trade pact to roll back their bruising 16-month long tariff war.

People familiar with the negotiations have told Reuters that China is pushing U.S. President Donald Trump to remove the Sept. 1 tariffs as part of a "phase one" U.S.-China trade deal,

The optimism around a trade deal lifted the yuan on Tuesday despite the PBOC cutting the interest rate on its one-year medium-term lending facility (MLF) loans, a closely watched policy lending rate, by five basis points.

Market observers saw the small cut in the one-year MLF rate as a salve for the onshore bond market, which has been hit by a selloff in recent months amid worries that relatively high consumer inflation impeded Beijing's ability to ease policy despite slowing domestic growth and the protracted trade war.

Chinese 10-year Treasury futures for December delivery , the most-traded contract, trimmed earlier gains to edge up 0.05% in the afternoon. They had jumped 0.35% the previous day following the MLF cut.

The yield on China's benchmark 10-year treasury bonds had risen nearly 30 basis points from September lows before the PBOC's latest MLF cut. The bonds yielded 3.284% on Wednesday, according to Refinitiv data, down about 1.5 basis points from Monday, before the cut was announced.

A trader at an Asian bank in Shanghai said the rally in Chinese government bonds on Tuesday did not mean the market has shed its cautious stance.

"The (MLF) cut was outside of market expectations, and the fall in yields yesterday mainly reflected short covering. The market is paying attention to whether there will be a cut in open market operation rates or the Loan Prime Rate," she said.

Analysts at Bank of America Merrill Lynch cautioned that the MLF cut, and a likely reduction in the central bank's benchmark Loan Prime Rate (LPR) in November would have a limited impact.

The LPR is linked to the MLF rate and is set on the 20th of each month.

"The actual impact on driving down bank loan pricing and servicing the government mandate of lowering funding cost for corporates is likely to be quite limited. After all, the lower LPR only applies to the new loans, but the pricing of the existing loans is still based on the benchmark interest rates," they said.

China's equity markets, which had risen for three consecutive sessions on the buoyant mood around trade talks, stepped back on Wednesday.

The country's benchmark Shanghai Composite Index gave up early gains to fall 0.32% in the afternoon session. The blue-chip CSI300 index was down 0.33%.

Hong Kong's Hang Seng turned around from losses to add 0.05% early in the afternoon. Hong Kong-listed H-shares added 0.03%.

(Reporting by Andrew Galbraith Editing by Shri Navaratnam)