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--Traders Expect Tight Bias On Liquidity Next Year
--Bond Market Still Bearish Due To Strict Regulations in 2018
BEIJING (MNI) - Traders in China's interbank market will be glad to see the
back of 2017, a year that piled on the misery as the months progressed.
The market witnessed an across-the-board tightening of rules that developed
into a full-blown regulatory storm in March and April aimed at forcing financial
institutions to deleverage. The central bank raised money-market interest rates
twice in the first quarter and changed tactics on reverse repos, offering more
money at longer maturities, to raise borrowing costs further and inflict more
pain on highly leveraged institutions.
On top of that, banks saw a crackdown on wholesale funding through tighter
controls over the issuance of negotiable certificates of deposit (NCDs) while
the bond market rout continued as the regulatory campaign squeezed liquidity and
leverage, sending yields on benchmark 10-year government bonds above 4% in
November for the first time in three years.
Last week, just as the finishing line was in sight, the People's Bank of
China gave the markets an early Christmas present in the form of an unexpected,
albeit mild, five basis-point increase in three key interbank lending rates --
the seven-day and 28-day reverse repos, as well as the Medium-Term Lending
Facility -- in a symbolic next-day response to the U.S. Fed's 25 basis-point
hike in the federal funds rate.
The central bank also on Monday raised the 14-day repo rate by the same
five basis points.
"Traders in the interbank transaction department of banks have had a hard
year both physically and psychologically," a trader with a small city commercial
bank in eastern China told Market News International. "Small banks like ours
have suffered under really big pressure and traders are looking at pretty meagre
"At the beginning of the year our bank targeted keeping our funding costs
below 3.8%, but now the price of 14-day money is around 4% and went as high as
5% during some tight periods in the year. The PBOC shows no sign that it change
its monetary policy stance so I think there's going to be another tough year
--LIQUIDITY LOOKS GOOD FOR NOW
Nevertheless, the central bank, which is under government orders to pursue
a "prudent and neutral" monetary policy, did provide some Christmas cheer,
maintaining a good level of funding to ensure the market dodges a year-end
liquidity crunch. Quarter-end cash squeezes, especially in December, are a
perennial worry for traders as larger banks, which provide most of the funds for
the interbank market, traditionally hoard cash at this time of year to ensure
their books satisfy the increasingly tough regulatory requirements of the PBOC
and the China Banking Regulatory Commission.
Almost 37% of traders polled in the latest Market News International
monthly interbank survey said liquidity conditions are better than they were the
previous month, compared with just over 5% in November's survey, while those who
said conditions are worse fell to 42% from almost 74% the previous month.
The MNI survey gauged the opinions of 19 traders with financial
institutions operating in the interbank market, the country's main platform for
trading money-market, bond and currency instruments, and the main funding source
for financial institutions. Interviews were conducted from Dec. 12 to Dec. 15.
"We are going to see some volatility in liquidity because demand for money
is going to increase over the period crossing into January, but I don't think
we're going to see a liquidity crunch like we saw last year," a trader with a
large state-owned bank in Shanghai said. "The targeted cut in banks' reserve
requirement ratio will also kick in, and as that's going to cover about 80% of
the banks, we won't see much tightness in January either."
The PBOC announced on Sept. 30 that it would make selective cuts to banks'
reserve requirement ratios (RRR) starting on Jan. 1 based on how much they lent
in 2017 to small and micro enterprises and to other borrowers that fall under
the government's "inclusive finance" label, which includes the agricultural
sector, start-ups, students and those living under the poverty line.
Another trader noted that the central bank restarted 28-day reverse repos
in December to help counter a possible shortage of funds over the cross-month
period, while a trader with a state-owned bank in southern China said the CNY288
billion injection of Medium-term Lending Facility loans last week more than
offset the CNY187 billion of maturing MLFs, giving a shot in the arm to market
--GUIDING MARKET RATES
But even as the central bank makes sure the market isn't short of funds, it
has been guiding market rates higher partly by increasing its offering of
higher-cost longer-term money and cutting back on cheaper short-term funding.
It has also had to take account of the Fed's normalization of interest
rates, and while it hasn't acted in lock-step with the U.S. central bank, it did
raise money-market rates across the board in the first quarter by a total of 20
basis points, taking the rate on the benchmark seven-day reverse repo up to
2.45%. It also hiked the one-year MLF rate in the first quarter by 25 basis
points to 3.20%.
After the most recent round of rate hikes, the seven-day repo rate is now
at 2.50%, the 14-day repo rate is at 2.65%, the 28-day is at 2.80%, and the
one-year MLF rate is at 3.25%.
But that still leaves the reverse-repo rate well below the deposit repo
rate (which reflects the cost of borrowing among banks), with the seven-day
drepo rising by nine basis points last week to end the week at 2.9195.
"That five basis point increase really wasn't a big deal," said a trader
with a city commercial bank in northeast China. "Those policy rates are not
reflecting the real repo rates in the market at all -- the gap just keeps
getting wider because market rates are rising."
The volume weighted average price of the seven-day deposit repo jumped from
an average of 2.5061% during the second week of December 2016 to 2.9091% in the
same week this year, and rose as high as 2.9457% last Wednesday, while the price
of the seven-day repo, which reflects the cost of borrowing for all financial
institutions, rose from an average of 3.0458% in the Dec. 12-16 period last year
to 3.4446% last week.
But for the third straight month, the majority of respondents in the MNI
survey -- 73.7% -- still see seven-day repo rates going even higher over the
next two weeks as demand for money rises from institutions covering their
cross-year funding needs.
--BOND MARKET CLOUD
Traders are slightly less pessimistic about the outlook for 10-year
government bond yields after the bond rout in November saw yields surge past the
key psychological level of 4%. The percentage of respondents who see yields
moving higher edged down to 52.6% in December's survey from 57.9% in November,
which was the highest percentage since April's poll. Just over a fifth of
traders said they expect 10-year CGB yields to fall, up from 15.8% in the
But the cloud of tighter regulation will still hang over the bond market
next year, traders said, pointing to the draft of a new unified regulatory
framework for the asset management sector published by the PBOC in November. The
rules will set limits for leverage ratios and risk reserve funds, and impose
investment restrictions on asset management products issued by all financial
institutions, with the aim of reducing leverage and arbitrage.
"Financial institutions, even the big state-owned banks, have reacted
strongly against the draft rules, but regulators are insisting they won't back
down," said a trader with one of the Big Four state-owned commercial banks in
Shanghai. "This is going to be bearish for the bond market next year as
financial institutions will have to adjust the structure of their asset
management products, and that's going to hit demand for bonds."
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