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MNI China Money Week: Improved Liquidity Fuels Bond Rally

MNI (London)
     BEIJING (MNI) - Improved liquidity conditions in the China money markets
have pushed bond yields lower in the last week, as some investors become more
optimistic about the outlook of liquidity. However, longer-term liquidity
concerns remain.
     The yield on the 10-year China Government Bond (CGB) and China Development
Bank bonds fell 5 and 8 basis points respectively, from 3.8702% and 4.8946% last
Friday to 3.8201% and 4.8101% on Thursday, back at yields last seen in December.
     Increased optimism over liquidity conditions remain the key driver for
lower bond yields. This pick-up in sentiment was helped Monday when the PBOC
injected a net of CNY150 billion into the banking system via its open market
operations despite ample liquidity in the system, contradicting expectations
that the People's Bank of China will actively drain liquidity from the banking
system after the spring holidays.
     More optimistic investors expect a change of monetary policy stance, with
last year's tight liquidity position moving to a more neutral stance this. The
optimism is triggered in part by the change of wording in the PBOC's fourth
quarter monetary policy report, with the central bank saying it looks to keep
liquidity conditions "reasonable and stable" from "generally stable" in the
third quarter report.
     With tight regulation set to continue in 2018 -- the widely-anticipated
asset management industry regulations are likely to published soon -- and with
the PBOC likely to hike its open market operations rate this year following rate
hikes by the Federal Reserve, liquidity will likely remain slightly relaxed to
help avoid systemic financial risks. The ample liquidity will help underpin the
domestic bond market.
     With the Two Sessions of National People's Congress and Chinese People's
Political Consultative Conference to be held in the early March, liquidity will
likely to remain relaxed as to keep the stability of the financial system in the
short run, providing a healthy environment for bond investors.
     However, longer-term liquidity remains questionable.
     There are concerns that if liquidity remains relatively stable it will
likely encourage financial institutions to again boost leverage, against the
PBOC's wishes. It will provide a carry margin for investors to borrow short-term
money and hold longer-term assets. Even if liquidity tightens occasionally, the
average cost will likely remain lower than the returns, making leveraging an
attractive strategy for financial institutions.
     Despite the recent recovery for bonds, it is too soon to call a market
renaissance. More local government bonds and policy bank bonds will be issued
after the Two Sessions, putting upward pressures on bond yields. New
regulations, likely effective after two Sessions, will cause uncertainties in
the market.
     Additionally, banks, the most important buyers of bonds, are lacking
long-term liabilities. The primary market rates of six-month negotiable
certificates of deposit (NCD) issued by city commercial banks rose to 5.10% on
Wednesday, the highest since the end of January, shows banks' appetites for
longer-term liabilities. The lack of stable long-term liabilities will restrict
banks' capabilities to invest in bonds.
--MNI London Bureau; tel: +44 203-586-2225; email:
[TOPICS: M$A$$$,M$Q$$$,MK$$$$,MX$$$$,M$$FI$,MN$FI$,MN$MM$]
MNI London Bureau | +44 203-865-3812 |

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