MNI CHINA MONEY WEEK: Liquidity-driven Bond Bounce Won't Last

--End Of China New Year Liquidity Injections Could Weigh On Bonds

     BEIJING (MNI) - China Government bonds were higher this week, enjoying a

rally driven by the continued improvement in liquidity conditions. However,

there are concerns the rebound could be short lived as liquidity condition will

likely tighten again after the Chinese New Year Holiday.

     The yield on the ten-year China Government Bond (CGB) fell 4.67 basis

points from 3.9167% Monday to 3.8700% on Wednesday, benefitting from safe-haven

flows as risk averse investors took fright at the global stock market sell-off,

according to data from Chinabond.

     However, there is a deeper reason helping fuel the bond rally -- abundant

liquidity in the interbank market. 

     In order to help financial institutions prepare for the Chinese New Year

Holidays, which often sees a surge in cash needs, the People's Bank of China

used the Contingent Reserve Allowances (CRA), which enabled national commercial

banks to use up to 2% of their deposit in their reserves to meet cash needs.

     The CRA's impact, a net injection of around CNY2 trillion according to the

PBOC, has been to make liquidity conditions relatively relaxed, despite the

PBOC's constant effort to drain. Some interbank liquidity traders described

January as "the most relaxed month ever," highlighted by the monthly average

spread between the seven-day repo and seven-day deposit repo, which was 39.8

basis points, the lowest since May last year.

     As a result, the ten-year CGB yield fell from a peak of 3.9797% on Jan 18

to 3.8700% on Wednesday.

     --REBOUND REVERSAL

     However, it is doubtful whether the bond market bounce has further to run.

     With liquidity conditions likely to be tighten after the Spring Festival

and the the impact of CRA set to fade after the holiday, there are few reasons

to believe that liquidity will remain loose. During its annual work meeting, the

PBOC stated it will keep liquidity conditions "reasonable and stable,"

underlining that an over-abundant liquidity condition is not what the PBOC

wants.

     Concerns over tighter financial regulation and a strong economy linger,

also capping further gains. This is seen in the steepening CGB yield curve. The

term spread between one-year CGB and ten-year CGB has widened from 8 basis

points on Dec 29 to 48 basis points on Thursday. 

     In part, this shows the liquidity pick-up has mainly benefited the front of

the curve, with investors not yet confident over long-term bonds.

     The same pattern also shows up in primary market, short-dated bonds

generally finding better demand than the long-end of the curve.

     --EYE FUNDAMENTALS

     Bond investors are closely watching economic data, especially domestic

credit data, looking for evidences suggesting China's economy has weakened. The

January import and export data, released Thursday, were stronger than expected,

which hurt the bond market and caused the 10-year CGB bonds yields to rise 1.01

basis points on Thursday.

     The next focus is next week's credit data, in particular the new loans

numbers. However, some watchers urge caution, as the new loans data will include

the impact of converting non-standard assets to loans, which will prop up the

numbers and actual new loan demand will be lower than the data suggests.

     Overseas bond market might have a negative impact on the China market. The

spread between ten-year CGB and U.S. Treasuries fell to around 105 basis points

on Thursday, around historical average levels. If UST yields rise, CGB yields

could follow them higher in sympathy.

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com

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

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