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--PBOC Seen Not Following Fed To Avoid Damaging Economy
--PBOC May Keep Long Rates High, Short Rates Low With Sufficient Liquidity
BEIJING (MNI) - The increases in money market instrument interest rates by
the People's Bank of China on Thursday won't have a substantial impact on the
domestic bond market as the hikes do not signal a start of a monetary policy
tightening cycle, traders and analysts say.
On Thursday morning, the PBOC hiked its seven-day and 28-day reverse repo
rates by five basis points each to 2.50% and 2.80%, respectively. It also
increased its one-year Medium-term Lending Facilities (MLF) rate by the same
amount to 3.25%, after the Federal Reserve announced on Wednesday that it had
increased its fed funds rate target by 25 basis points to 1.25% to 1.5%, as
However, the PBOC did not change its benchmark interest rates. The
benchmark deposit rate remained unchanged at 1.50%, while the benchmark loan
rate was stable at 4.35%.
--RATE HIKE NO SURPRISE
The PBOC's rate hikes came as no surprise to the bond market, with the
yield on the most-actively traded 10-year China Government Bond (CGB) falling
1.5 basis points to 3.910% and the yield on the 10-year China Development Bank
(CDB) bond dropping one basis point to 4.8350% on Thursday after the PBOC
announcement. Traders said the move had already been priced in.
"The fact that PBOC did not roll over its MLF loans [due to mature this
month] all at once as in the past several months triggered concern among traders
about a [PBOC] rate hike. So the previous boost [to the bond market] caused by
the China Development Bank's move to replace long-term bonds with short-term
issues has to some extent been counterbalanced," a Beijing-based trader at an
asset management company said. "I estimate that if there had been no rate hike,
then the CDB bonds would have fallen 5-8 basis points more [during the past
An easily overlooked interest-rate swap (IRS) product indicated that a
larger rate hike had been priced in.
"The fixed-deposit-repo-based IRS saw its bid and offer prices go up to
2.96% and 3.00% [respectively] last Thursday, with the seven-day fixed repo at
2.77% at that time. This showed the market was pricing in a 20 basis point
interest rate hike at that time," the trader said. "Even though there is very
little trading volume in this product, the deposit-repo-based IRS still shows
something as the deposit repo is the benchmark rate for the interbank market."
--NO PBOC TIGHTENING CYCLE
A more fundamental reason that bond market did not react badly to the rate
hike is that very few investors believe it was a signal of a monetary policy
tightening and also believe the PBOC has been trying its best to calm the
"The PBOC has made it clear that the size of the rate hike is 'slight',
showing that the PBOC is paying very close attention to market expectations and
is trying to avoid generating market fears about a potential tightening of
monetary policy," analysts at Guotai Junan Securities said. "The intention to
take care of bond market [sentiment] is obvious."
Analysts at China International Capital Corp. (CICC) noted that the PBOC
took remedial steps when market interest rates rose earlier in the fourth
quarter -- including initiating a 63-day reverse repo, increasing treasury
deposit auction amounts, and increasing communications with the market -- all of
which indicates the PBOC does not want to see interest rates rise too much.
Traders said the PBOC has firm control of interbank market liquidity
"Recently, short-term money is relatively loose, but long-term money
remains very tight," a central China-based interbank trader at a commercial bank
told MNI. "By injecting more long-term funds via its one-year MLF and reducing
short-term liquidity injections through reverse repos, the PBOC is helping
financial institutions to borrow longer-term money, showing the precision the
PBOC has in controlling overall liquidity conditions."
--PBOC WON'T FOLLOW FED
Sun Guofeng, head of the PBOC finance research institution, said last week
that emerging economies, including China, need to begin to normalize their
monetary policies to coordinate with developed countries, triggering market
worries about tighter PBOC monetary policy.
But traders said it is unlikely the PBOC will simply follow Fed rate hikes
considering the current downward pressure on Chinese growth.
"Fed Chair Yellen said the Fed will probably gradually hike its interest
rate over the next several years, not just next year," another Beijing-based
bond trader at an asset management company told MNI. "So if the PBOC simply
follows the Fed rate hikes and the Fed tightens its monetary policy for years,
that will mean the PBOC will tighten its monetary policy as well for years. But
is that really possible?"
"Our economy is durable, but not so much that it can hold up under a
constant tightening of monetary policy," the trader continued. "I believe the
PBOC will show monetary policy independence."
--NEW POLICY MIX
A more likely policy mix, analysts say, is relatively high longer-term
interest rates combined with sufficient liquidity and relatively stable interest
rates in the shorter-term portion of the market.
"The PBOC needs to follow the Fed interest rate hike to maintain a
relatively wide yield gap [between Chinese and U.S. bond yields] and to
stabilize the [yuan] exchange rate to provide a suitable environment for
deleveraging," Ming Ming, the analyst at CITIC Securities said in a report on
Thursday. "The five basis point rate hike this time shows the PBOC is likely to
hike its open market rates in small increments more frequently in the future so
as not to spook the market."
"In an environment in which interest rates are likely to remain high, it is
necessary for the PBOC to provide enough liquidity to keep short-term interest
rate stable," Ming said. "In detail, the PBOC will continue to provide liquidity
via targeted required reserve ratio cuts, open market operations and standing
lending facility [loans] to provide sufficient liquidity, so as to increase its
support for inclusive finance [for small businesses and farmers] to adjust the
structure of the credit market and to ensure steady economic growth."
Analysts also reminded investors that it is possible the PBOC will raise
its benchmark interest rates next year.
"If the Consumer Price Index rises to around 3% next year, the benchmark
deposit rate is 1.5%, which is quite low. Raising the benchmark deposit rate can
also help banks bring in new deposits and so alleviate their shortage of deposit
funds," Ming said.
"But the benchmark loan rate is unlikely to rise because the PBOC wants to
support the real economy. So an asymmetrical rate hike could happen, with an
increase in the benchmark deposit rate while keeping the benchmark loan rate
unchanged," he said.
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