MNI China Money Week: Stay On Guard For Bond Yield Rebound

     BEIJING (MNI) - China bonds continue to trade in a buoyant mood, but, with

the economy still upbeat and liquidity conditions likely to tighten into

quarter-end, there is the possibility of a trend reversal in coming weeks. 

     Since the end of January, yields on Chinese Government (CGBs) and China

Development Bank (CDB) Bonds have fallen around 10 and 21 basis points to

3.8413% and 4.8562% on Thursday, mainly driving by the easier liquidity

conditions and an expectation that China's economy will slow in the first

quarter.

     Economic data released Wednesday shows a still healthy economy. Industrial

output, fixed asset investments and real estate investments all outperformed

market expectations, with retail sales only slightly below expectation.

     The divergence in market consensus on economic growth and the actual data

will lead to an upward revision of market expectations on underlying growth.

This situation is similar to Q4 2017, when investors bet on a weaker China

economy but the actual data proved them wrong, pushing 10-year CDB bond yields

more than 40 basis points higher in a month.

     --MARKETS UNFAZED

     However, the ten-year CDB bonds yields rose only 2 bps Wednesday,

underlining the liquidity impact. Since January, the PBOC has maintained

liquidity at a more relaxed condition that last year, fuelling market

expectation that the monetary policy stance is going to be more relaxed this

year, pushing bonds yields lower.

     As quarter-end approaches, liquidity will likely tighten as larger banks

horde cash, not wanting to lend to small banks and non-bank financial

institutions as they have to meet the requirements set by regulators, including

amongst others macro prudential assessments (MPA) and capital adequacy ratio

tests.

     Whether the PBOC keeps liquidity condition relaxed into the quarter-end

will be a test of the PBOC's attitude; and with a new governor taking office,

central bank actions will likely reflect his opinion.

     Any tightening of liquidity, if it happens, will likely push yields higher,

although not to the extent seen in Q4 when the trade was more crowded.

     --HEADWINDS

     However, even if the PBOC keeps the liquidity more relaxed than last year,

a possibility after the PBOC made net injection via its Medium-term Lending

Facilities loans without hiking the rate on Friday, the room for lower bonds

yields remains quite limited, in part due to the lack of big banks'

participation. 

     In February, national commercial banks increased their holdings of policy

bank bonds by CNY5.1 billion, significantly down from CNY101.6 billion in

January. At the same time, funds increased their holdings by CNY100.3 billion.

     Traders note a significant difference between short-term investors and

long-term investors, with the former more enthusiastic about bonds, with the

latter more pessimistic. 

     Regulation remains a big factor affecting banks and tighter rules will keep

funding available to buy bonds capped. With local government bond supply also

set to pick up, bonds market will still suffer headwinds.

     If the PBOC keeps liquidity relatively easy into the quarter end, that will

show the monetary policy stance is more relaxed. Then, if the economy shows

signs of slowing down or funding demand contracts in the future, bond market

opportunities will reappear.

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

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

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