MNI China Money Week: Bond Investors Stake Out Short-Term Bets

--With Looser Liquidity On Horizon, Expectations Shift

     BEIJING (MNI) - Although there are few signs that the bond bear market is

coming to an end, bond investors have begun to bet on short-term opportunities

as they see liquidity becoming looser and August economic data may prove weaker

than in past months.

     Liquidity conditions improved the past week compared with previous weeks.

The CFETS-ICAP money market sentiment index averaged 43.25 this week, down from

59.7 and 59.2 in the previous two weeks. A lower index reading suggests an

improvement in liquidity conditions.

     Meanwhile, repo rates stayed at about the same level. The benchmark

seven-day deposit repo (drepo), available only to banks, averaged 2.8247% this

week, down from 2.9163% last week. The seven-day repo rate, reflecting the

borrowing costs of all financial institutions, averaged 3.1689% this week,

compared with 3.8239% last week.

     The continued firm stance of the People's Bank of China to keep liquidity

conditions neither loose nor tight has changed some traders' expectations, with

more saying they want to play it safe.

     "Liquidity conditions remained quite good today," an interbank trader based

in southern China said on Tuesday. "But the PBOC's stance makes me suspect the

good times will not last long, and maybe we will see a turning point" soon. 

     "The good times make people forget about past weeks, when the market became

very tight, so I'm starting to borrow money now to prepare for the quarter-end,"

the interbank trader said, as banks need to dress up results for

macro-prudential tests along with other tests.

     On Wednesday, the PBOC injected CNY20 billion via 28-day reverse repos, the

first time since July 17 it had used the longer-duration repo, a move seen by

some traders as a signal that the central bank intends to keep the market

relatively loose in September ahead of the quarter-end. 

     "Now I see the market is still quite pessimistic and cautious about

liquidity conditions, but they do not have to be," a trader at a securities

brokerage said on Wednesday. "The 19th National Congress will open soon in

mid-October, and the PBOC just released a loosening signal today [the 28-day

repo], so I expect liquidity conditions to remain good for a while." 

     The securities brokerage trader added that the restart of 28-day reverse

repo operations suggests the PBOC intends to help financial institutions get

past the end of the quarter in smooth fashion.

     The PBOC's injection of a net CNY128.5 billion on Thursday in one-year

Medium-Term Lending Facility (MLF) instruments also bolstered the case that the

PBOC intends to caress liquidity conditions this month.

     Besides the "signal" the PBOC's open-market operations sent, analysts

argued that liquidity conditions will improve in September as the tools the PBOC

usually uses to drain liquidity from the market become more limited.

     "The main tool for the PBOC to drain liquidity from the banking system is

to let reverse repos expire, and the existing reverse repos only amount to

CNY110 billion in September right now," Xu Hanfei and Liu Yu, analysts at China

Merchant Securities, noted in a report Thursday. "So liquidity conditions will

not be very tight in September, and might be quite loose at the end of September

due to fiscal expenditures," so long as the PBOC does not actively use repos to

drain liquidity from the market, which it last did in November 2014. Local

governments tend to increase fiscal expenditures at the end of each month,

causing liquidity to improve.

     The market is also awaiting August economic data to provide more

information about the direction of China's economy.

     "In June, the data suggested that economic growth was stronger than the

market expected, while the July data suggested exactly the opposite, which gave

the market mixed expectations on the Chinese economy," Guosen Securities said in

a report on Thursday. "Now the market is watching August and also September data

to provide further evidence on the economic situation; for example, if

fixed-asset investment, especially real estate investment, will be weaker or

not."

     Analysts say betting that economic conditions will weaken seems like a good

strategy for the time being, as the higher government treasury yields provide an

asymmetric payoff: limited risk of losses but good potential for gains.

     "The domestic bond market has been trending down since the beginning of the

year," Qin Han and Gao Guohua, analysts at Guotai Junan Securities, said in

their Thursday report. "As September liquidity conditions could very possibly

get better, there will be fewer reasons for the bond market to fall. If economic

data prove that economic conditions are weak, the already low bond market will

have massive space to rise."

     The most actively traded 10-year government treasuries, which mature on

Aug. 3, 2027, yielded 3.6350% at Thursday's closing, not far below the 3.7%

level considered almost unbreakable by the market. 

     On Wednesday, the Ministry of Finance auctioned a relatively huge tranche

of CNY80 billion in 10-year treasuries at a yield of 3.6341%, which was better

than expected and showed that banks have a strong desire to hold long-term

treasuries -- a situation that could benefit treasury yields in the secondary

market.

     Traders also said there were rumors on Thursday that the PBOC issued window

guidance that three-month negotiable certificates of deposit (NCDs) shall not

have yields of more than 4.70%, a move interpreted by the market as meaning the

PBOC thinks that current NCD interest rates are too high, encouraging bond

investors.

     However, recent moves by regulators, including last week's prohibition on

the issuance of NCDs with durations of over a year, along with money market fund

guidelines restricting their investment range and development speed, have

created concern that tightening regulations will hurt bond market sentiment. 

     "Although liquidity conditions have been good recently, the new rule on

money market funds makes the market worry that strict regulations will come

back," a Beijing-based bond trader at a commercial bank said. "The factors above

and the good Purchasing Managers Index (PMI) number, suggesting potentially good

economic conditions, explain why the yields are still trending up." 

     The official manufacturing PMI was 51.7 in August, beating market

expectations of 51.3 according to an MNI survey and slightly higher than the

51.4 reading seen in July. 

     Some analysts said that investors need to remain patient for the time being

and wait for more clear-cut long-term opportunities to appear.

     "It is certain that the strict regulations will continue for a while, which

will restrict the expansion of liabilities by financial institutions ... and

non-bank financial institutions will suffer from more pressure on the

liabilities side," Tang Yue and Huang Weiping, analysts at Industrial

Securities, said in a report on Monday. "So the instabilities of the market have

not been solved and the market will face a negative impact caused by liquidity

and credit contractions."

     "A good time to buy long-term bonds will appear when we observe a widening

of the credit spread and the deleveraging of non-bank financial institutions

caused by liquidity and credit contraction," Tang and Huang continued. "We

suggest investors be flexible and hold a portfolio with a relatively shorter

duration, and wait for bigger opportunities after the instabilities have been

resolved."

--MNI Beijing Bureau; +86 10 85325998; email: he.wei@marketnews.com

--MNI Beijing Bureau; +86 (10) 8532-5998; email: vince.morkri@marketnews.com

--MNI BEIJING Bureau; +1 202-371-2121; email: john.carter@mni-news.com

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