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MNI China Money Week: Cautious Mood Short-Circuits Bond Rally

--Investors Strain To Read Tea Leaves on Weak Economic Data
--Liquidity Tightens, Confidence Wanes
     BEIJING (MNI) - Last week's rebound in China's bond market, spurred by
disappointing August economic data and lower rates on negotiable certificates of
deposit (NCDs), fizzled out this week, leaving investors and traders scratching
their heads over why the rally was so short-lived.
     The yield on one of the most-traded 10-year China government bonds (CGB)
maturing on Aug. 3, 2027, edged up from 3.6025% last Friday to 3.6350% on
Thursday, taking it back almost to the level before the mini-rally started two
weeks ago.
     Based on the rallies that occurred in the end-of-quarter months of March
and June, traders had expected the bond run-up to last longer, especially given
the key 19th Communist Party Congress in mid-October. The congress, which takes
place every five years, should be good news for the bond market as the party
pulls out all the stops to maintain stability and create positive sentiment in
the markets ahead of the event.
     Various explanations have been doing the rounds as to why the rebound
barely saw the light of day. 
     One view is that the market doesn't believe that the poor economic data are
an accurate reflection of conditions in the Chinese economy.
     "Although the economic data in August were worse than expected, most
investors think the weak data were partly due to the campaign to control
industrial production to protect the environment, and that they need to see more
data to assess the underlying state of the economy," Qin Han and Liu Yi,
analysts at Guotai Junan Securities, said in a report this week. "Consequently,
investors are not quite sure whether the weak economic data really is good news
for the bond market."
     Another possibility is the tightening of liquidity, arguably the most
important factor driving the bond market.
     "Liquidity conditions became tighter this week due to the impact of tax
payments, reserve-requirement payments and government bond issuance purchasing,"
Qin and Liu said. "As the quarter-end approaches, which might cause liquidity to
tighten again, the market still lacks confidence in bond investments."
     The CFETS-ICAP money market index, which measures liquidity conditions in
the interbank market, averaged 59 this week, higher than the 53.5 last week,
suggesting slightly tighter liquidity conditions.
     The benchmark seven-day deposit repo (drepo) rate, which reflects borrowing
costs for banks in the interbank market, averaged 2.9359% over the week, the
highest since the week of June 19-23, and higher than 2.878% last week. The
seven-day repo rate, which reflects borrowing costs for all financial
institutions, rose as high as 3.8963% this week and averaged 3.7729%, above last
week's 3.389%.
     The higher rates came despite central bank injections via open-market
operations to ease strains in the market, suggesting that the addition of
funding wasn't enough to meet demand.
     The People's Bank of China pumped a net CNY260 billion into the market via
OMOs last week, the most since the last week of July. It added a further net
CNY450 billion in the first two days of this week, although most of that was
aimed at countering the impact of maturing Medium-term Lending Facility (MLF)
loans, the issuance of government bonds and other seasonal factors that drain
money from the system, including tax payments and reserve-requirement deposits
at the central bank.
     "Although the large net injection shows the PBOC was looking out for the
market to some extent, liquidity remains tight and I've been begging for money
in the mornings," an interbank trader with a commercial bank in southern China
told MNI. "The PBOC needs to provide more money to help us."
     As liquidity conditions stabilized mid-week, the PBOC pulled back and only
rolled over maturing reverse repos on Wednesday, Thursday and Friday, indicating
a return to its stance of keeping liquidity conditions stable. 
     "This month, the PBOC has transacted more seven-day reverse repos than
14-day and 28-day reverse repos that would help financial institutions manage
their liquidity over the quarter-end," said Ming Ming, an analyst at CITIC
Securities. "Additional seven-day repos give the PBOC more room to address
volatility in liquidity toward the end of the quarter. If [government] fiscal
spending adds a large amount of liquidity to the system, the central bank can
choose not to roll over the maturing reverse repos to balance the extra funds
and keep liquidity stable."
     The tighter liquidity conditions also caused NCD rates to move higher this
week as institutions had less money to play with. The average coupon rate of
three-month NCDs issued by joint-stock banks went up from 4.2800% last Friday to
4.3938% on Thursday, the biggest rebound since the last week of August.
     The pressure from tighter liquidity has made financial institutions less
willing to buy bonds.
     "Commodities prices have been falling, especially ferrous metals prices," a
Beijing-based bond trader with a commercial bank said. "That should be good news
for bonds, because falling commodities prices suggest a lower risk of a rise in
inflation. But financial institutions aren't paying attention to this. They
aren't interested in trading bonds right now because they are too busy trying to
get money."
     The Communist Party Congress, where President Xi Jinping is expected to
consolidate his power and set out a vision for his second five-year term, has
also failed to lift bond investors' sentiment.
     "Many market investors anticipated that regulators would ensure stability
before the congress and were expecting there would be trading opportunities, but
now the thinking has already turned to what might happen after the congress,"
the Beijing bond trader said. "If the financial deleveraging campaign continues
and liquidity remains tight, bonds yields are more likely to go up than down."
     Even so, some analysts believe the bond rebound will continue and that the
market was just taking a breather this week.
     "It is normal for the market to fluctuate when it's going up, because
investors have not reached a consensus over the direction of the bond market,
and they can be easily influenced by bad news," Xu Hanfei, an analyst at China
Merchant Securities, said on Wednesday. "But most of the evidence, including
declining commodity prices and weak economic data, is pointing to a likely fall
in bond yields, so we think yields will continue to decline, although the path
might be slow and hesitant unless there is some unexpected bad news for the bond
     Some analysts say that while they don't necessarily agree with that view,
they think it is still a good time for bond investors to start building
     "The PBOC's monetary policy will likely remain prudent and neutral and as
regulatory policies become clearer, market expectations stabilize and the
economy weakens in the fourth quarter, we believe there will be opportunities in
the fourth quarter for bond investors," Meng Xiangjuan, Qin Tai and Liu Ning,
analysts at Shenwan Hongyuan Securities, said on Monday. "So bond investors
should begin to build positions before the turning point emerges in the fourth
     Analysts at Haitong Securities also see opportunities emerging. "The
turning point of the economy has already appeared, which indicates that the
chance for long-term bond yields to rise further has edged down," Jiang Chao,
Zhou Xia and Zhu Zhengxing said on Thursday. "However, if the PBOC remains firm
in not relaxing its monetary policy stance, short-term bonds yields will not
fall much, so the yield curve will remain flat and may even invert."
     "History shows that China's bond market can go through a full round of bear
and bull markets over a three-year period," they said. "In 2016, the bond market
went from a bull market to a bear market and remained in bearish territory for
all of 2017. That means we could see a bull market in 2018."
     However, they cautioned that if the rally is driven by weak economic
conditions rather than a relaxation in monetary policy, it may be a very slow
     Yuan went weaker further this week following the depreciation last week. It
was last traded at 6.5903 versus dollar Friday morning, compared with 6.5442 at
last Friday's closing. 
--MNI Beijing Bureau; +86 10 85325998; email:
--MNI BEIJING Bureau; +1 202-371-2121; email:
--MNI Beijing Bureau; +86 (10) 8532-5998; email:
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