Efforts to spur credit demand have led to flush interbank market conditions.
A liquidity feast in China’s interbank market is likely unsustainable into the second half of the year if the central bank acts to curb money supply based on economic and credit indicators that are now sending a warning signals, market analysts said, as they cautioned investors to reduce leverage in short-duration debt in their portfolios.
The People Bank of China may guide money market rates up, approaching their policy rates, if the economy continues to improve. As a result, investors may have to reprice the yield curve, said Qin Han, analyst at Guotai Junan Securities, suggesting it is time to prepare for any unexpected deterioration in liquidity conditions.
Banks face the PBOC’s regular quarterly assessments of their balance sheets at a time of seasonal liquidity shortages in June when the central bank mostly provides additional help. However, so far this month, the PBOC has made just a net injection of CNY50 billion in total via its open market operations and rolled over the maturing medium-term lending facilities on June 15. The widely-expected 14-day repo rate has also not been offered.
PBOC’s recent operations may be a clear signal that the interest spread between market rates and their policy rates is vanishing, Qin said.
Since April, money market rates have been significantly lower than policy rates on liquidity overflows into the wholesale market after the PBOC’s series of easing moves, including a cut in the reserve requirement ratio, increases in relending tools, and a turnover of its profits.
Currently, the seven-day interbank repo rate, a key gauge for the liquidity condition, is swinging in a range of 1.5-1.7%, compared with the 2.1% policy rate of seven-day reverse repurchase agreement of PBOC’s OMOs.
Chen Daofu, senior fellow at the State Council Development Research Central, said in a forum recently that the big trading volumes in the wholesale market and the narrowing credit interest spread between corporate bonds and Chinese government bonds (CGBs) have indicated liquidity has piled in the interbank market, resulting from strong support of monetary authorities and amid weak credit demand. He noted that excessively easy monetary policy is not able to boost the economy without more positive fiscal moves.
ECONOMIC OUTLOOK, HIGHER RATES
Analysts from China International Capital Corp predicted however that monetary market rates would not rise sharply since the PBOC is unlikely to reverse its easing stance this year. A key reason is the economic recovery from pandemic curbs may be slower than expected and the prospect of overseas inflation may undermine China’s stimulus efforts.
Monetary policy would not head toward a neutral bias before the economy sees improvement in an obvious way, the equity market rises significantly and debt default is effectively controlled, they said.
Money market rates are expected to further fluctuate in July as the liquidity gap may expand to about CNY610 billion, which would depend on PBOC injections as other channels supplying money are reducing, including tax rebates and the transfer of PBOC profits to the government, said analysts.
China Industrial Securities estimated the yield of 10-year government bond would be up in a range of 2.7% to 3.15% in the second half of this year, from the current level around 2.8%.
A rising trajectory of market rates will weigh on investors who have added leverage by borrowing cheap money and increased exposure to the high-yield debt products.
LOCL GOVERNMENT BONDS
According to CICC, since April, yield-hungry wholesale market players have complained about a shortage of investing products as the debt issuance of local government financing vehicles (LGFVs) and developers, which used to provide high yields, has been shrinking under strict regulations. The brokerage predicted the shortage would get worse in H2 and push financial institutions to even lower-yield debt instruments.
One favourite of investors is LGFV bonds even though they are the targeted by the government as implicit debt. Analysts said the yields of LGFV bonds however is falling in the long term, but investors are betting on its short-term low risk as China boosts infrastructure investment and regulators may help control defaults in a background of credit expansion. In addition, their higher yield of about 4% to 8% is attractive.
According to Wind, both yields and credit interest spreads of one-year AA-rated LGFV bond are now at a historical low level due to the big appetite of investors . A total of 276 LGFV bonds was issued in May, among which 20 were oversubscribed by five times. On May 27, one LGFV bond issued by an investment company at Xinghua city in Jiangsu Province was 60 times oversubscribed.
China Chengxin Credit Rating Group suggested investors lengthen the duration of their investments and avoid over-exposure to short-term LGFV bond products in case liquidity deteriorates.