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REPEAT: MNI China Money Week: Bond Investors Look Short-Term

--Repeats Story Initially Transmitted at 08:01 GMT Sep 8/04:01 EST Sep 8
--With Looser Liquidity On Horizon, Expectations Shift
     BEIJING (MNI) - Although there are few signs that the bond bear market is
coming to an end, bond investors have begun to bet on short-term opportunities
as they see liquidity becoming looser and August economic data may prove weaker
than in past months.
     Liquidity conditions improved the past week compared with previous weeks.
The CFETS-ICAP money market sentiment index averaged 43.25 this week, down from
59.7 and 59.2 in the previous two weeks. A lower index reading suggests an
improvement in liquidity conditions.
     Meanwhile, repo rates stayed at about the same level. The benchmark
seven-day deposit repo (drepo), available only to banks, averaged 2.8247% this
week, down from 2.9163% last week. The seven-day repo rate, reflecting the
borrowing costs of all financial institutions, averaged 3.1689% this week,
compared with 3.8239% last week.
     The continued firm stance of the People's Bank of China to keep liquidity
conditions neither loose nor tight has changed some traders' expectations, with
more saying they want to play it safe.
     "Liquidity conditions remained quite good today," an interbank trader based
in southern China said on Tuesday. "But the PBOC's stance makes me suspect the
good times will not last long, and maybe we will see a turning point" soon.
     "The good times make people forget about past weeks, when the market became
very tight, so I'm starting to borrow money now to prepare for the quarter-end,"
the interbank trader said, as banks need to dress up results for
macro-prudential tests along with other tests.
     On Wednesday, the PBOC injected CNY20 billion via 28-day reverse repos, the
first time since July 17 it had used the longer-duration repo, a move seen by
some traders as a signal that the central bank intends to keep the market
relatively loose in September ahead of the quarter-end.
     "Now I see the market is still quite pessimistic and cautious about
liquidity conditions, but they do not have to be," a trader at a securities
brokerage said on Wednesday. "The 19th National Congress will open soon in
mid-October, and the PBOC just released a loosening signal today [the 28-day
repo], so I expect liquidity conditions to remain good for a while."
     The securities brokerage trader added that the restart of 28-day reverse
repo operations suggests the PBOC intends to help financial institutions get
past the end of the quarter in smooth fashion.
     The PBOC's injection of a net CNY128.5 billion on Thursday in one-year
Medium-Term Lending Facility (MLF) instruments also bolstered the case that the
PBOC intends to caress liquidity conditions this month.
     Besides the "signal" the PBOC's open-market operations sent, analysts
argued that liquidity conditions will improve in September as the tools the PBOC
usually uses to drain liquidity from the market become more limited.
     "The main tool for the PBOC to drain liquidity from the banking system is
to let reverse repos expire, and the existing reverse repos only amount to
CNY110 billion in September right now," Xu Hanfei and Liu Yu, analysts at China
Merchant Securities, noted in a report Thursday. "So liquidity conditions will
not be very tight in September, and might be quite loose at the end of September
due to fiscal expenditures," so long as the PBOC does not actively use repos to
drain liquidity from the market, which it last did in November 2014. Local
governments tend to increase fiscal expenditures at the end of each month,
causing liquidity to improve.
     The market is also awaiting August economic data to provide more
information about the direction of China's economy.
     "In June, the data suggested that economic growth was stronger than the
market expected, while the July data suggested exactly the opposite, which gave
the market mixed expectations on the Chinese economy," Guosen Securities said in
a report on Thursday. "Now the market is watching August and also September data
to provide further evidence on the economic situation; for example, if
fixed-asset investment, especially real estate investment, will be weaker or
not."
     Analysts say betting that economic conditions will weaken seems like a good
strategy for the time being, as the higher government treasury yields provide an
asymmetric payoff: limited risk of losses but good potential for gains.
     "The domestic bond market has been trending down since the beginning of the
year," Qin Han and Gao Guohua, analysts at Guotai Junan Securities, said in
their Thursday report. "As September liquidity conditions could very possibly
get better, there will be fewer reasons for the bond market to fall. If economic
data prove that economic conditions are weak, the already low bond market will
have massive space to rise."
     The most actively traded 10-year government treasuries, which mature on
Aug. 3, 2027, yielded 3.6350% at Thursday's closing, not far below the 3.7%
level considered almost unbreakable by the market.
     On Wednesday, the Ministry of Finance auctioned a relatively huge tranche
of CNY80 billion in 10-year treasuries at a yield of 3.6341%, which was better
than expected and showed that banks have a strong desire to hold long-term
treasuries -- a situation that could benefit treasury yields in the secondary
market.
     Traders also said there were rumors on Thursday that the PBOC issued window
guidance that three-month negotiable certificates of deposit (NCDs) shall not
have yields of more than 4.70%, a move interpreted by the market as meaning the
PBOC thinks that current NCD interest rates are too high, encouraging bond
investors.
     However, recent moves by regulators, including last week's prohibition on
the issuance of NCDs with durations of over a year, along with money market fund
guidelines restricting their investment range and development speed, have
created concern that tightening regulations will hurt bond market sentiment.
     "Although liquidity conditions have been good recently, the new rule on
money market funds makes the market worry that strict regulations will come
back," a Beijing-based bond trader at a commercial bank said. "The factors above
and the good Purchasing Managers Index (PMI) number, suggesting potentially good
economic conditions, explain why the yields are still trending up."
     The official manufacturing PMI was 51.7 in August, beating market
expectations of 51.3 according to an MNI survey and slightly higher than the
51.4 reading seen in July.
     Some analysts said that investors need to remain patient for the time being
and wait for more clear-cut long-term opportunities to appear.
     "It is certain that the strict regulations will continue for a while, which
will restrict the expansion of liabilities by financial institutions ... and
non-bank financial institutions will suffer from more pressure on the
liabilities side," Tang Yue and Huang Weiping, analysts at Industrial
Securities, said in a report on Monday. "So the instabilities of the market have
not been solved and the market will face a negative impact caused by liquidity
and credit contractions."
     "A good time to buy long-term bonds will appear when we observe a widening
of the credit spread and the deleveraging of non-bank financial institutions
caused by liquidity and credit contraction," Tang and Huang continued. "We
suggest investors be flexible and hold a portfolio with a relatively shorter
duration, and wait for bigger opportunities after the instabilities have been
resolved."

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