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REPEAT:MNI China Money Week: Econ Fundamentals Key In Bond Mkt

Repeats Story Initially Transmitted at 08:02 GMT Aug 18/04:02 EST Aug 18
     BEIJING (MNI) - Economic fundamentals have come into greater focus for
long-term bond traders and investors this week, with the recent spotlight on
liquidity conditions dimming ... for now.
     Liquidity conditions remained tight in the past week. On Tuesday, the PBOC
effectively drained a net CNY28 billion from the interbank market amid the
ongoing flow of tax payments, causing the CFETS-ICAP money market sentiment
index to close at 65 for the day, suggesting a tight liquidity level. Traders
said some financial institutions had defaulted on repos that day.
     "Today's liquidity condition was quite tight," a Beijing-based interbank
trader at a commercial bank said on Tuesday. "If you said in the QQ chatting
group that you have overnight money to lend out, your computer would shut down
immediately because there would be so many traders asking you the price at the
same time," he said. QQ is an instant messaging service widely used in China.
     On Wednesday, despite a net injection of CNY180 billion by the PBOC,
liquidity remained sticky, and the CFETS-ICAP index rose slightly to 66 at the
closing.
     "The tightness of liquidity conditions has been beyond market
expectations," the Beijing trader said. "Tax payments are just the surface
rationale," he said. "The root reason is the PBOC does not want liquidity
conditions to loosen too much."
     However, two consecutive trading days with tight liquidity did not help
lift the yields on 10-year government treasuries. The yield on the most actively
traded 10-year government treasuries, which mature Aug. 3, 2027, decreased from
3.5900% on Monday to 3.5750% on Wednesday, suggesting that liquidity is not the
main factor affecting long-term bonds yields.
     "The bond market's sensitivity to liquidity conditions has decreased," Xu
Hanfei and Wang Wanting, analysts at China Merchant Securities, said in a note
on Wednesday, adding that the liquidity tightness as measured by the increasing
spread between seven-day fixed repos and seven-day deposit repos -- which
widened to 113 basis points on Thursday from 19 basis points on July 14 -- had
caused much lower increases in long-term bond yields recently than in the past.
     "The relative insensitivity of long-term bond yields to liquidity
conditions probably suggests that the bond market leverage level has been
stable," Xu and Wang said. "The key factor affecting the bond market has shifted
from liquidity conditions to fundamental economic factors."
     Data published by the National Bureau of Statistics on Monday came in
weaker than expected. Industrial output grew 6.4% y/y in July, well below the
7.6% growth in June and the 7.0% expected in an MNI survey. Retail sales
increased 10.4%, down from the 11% increase in June and also below the 10.7% MNI
survey expectation. Property investment increased 7.9% during the January-July
period compared with the same period last year, down from 8.5% growth in the
first six months of the year. 
     Bond yields dropped after the data were released, with the yield on 10-year
government treasuries going from 3.6454% in the morning to 3.5900% at the close
Monday.
     However, stronger-than-expected credit and money data published Tuesday
puzzled investors, causing them to reconsider whether economic fundamentals were
in danger of weakening. Although M2 growth came in at a record low 9.2% rate for
the month, total social financing and new loans both exceeded expectations,
growing CNY1.22 trillion and CNY825.5 billion in July, respectively, though they
were both lower than the gains of CNY1.78 trillion and CNY1.54 trillion posted
in June. 
     Analysts have starkly different views on the outlook for China's economy,
with some, in line with the overwhelming market view, insisting that economic
growth is slowing. 
     "The fundamental supply-demand contradictions still exist: the high-speed
growth of manufacturing, the real-estate sector and infrastructure investment is
not likely to continue over the long run," Ming Ming, an analyst at CITIC
Securities, said on Monday. "So the evidence that the economic fundamentals have
improved has begun to weaken and the downward pressure on economic fundamentals
continues."
     Other analysts disagree.
     "We should not be too pessimistic about fundamental economic conditions, as
the July data were affected by adverse weather conditions," Hua Chuang
Securities said in a Monday report. "As temporary factors -- including high
temperatures, flooding and cuts in excess capacity -- fade away, the economic
data are likely to rebound. Even if the economic data continue to fall, if they
remain within the government's tolerance zone monetary policy won't be relaxed"
to benefit the bond market.
     Tang Yue, an analyst at Industrial Securities, said the July credit and
money data suggest the  financing demands of the real economy "remain steady"
and so economic fundamentals won't show signs of a weakening, at least in the
third quarter.
     Although economic fundamentals are likely to be the key factor affecting
bond market in the near future, some traders said the market should not forget
the lessons taught by regulators earlier this year and will likely remain
cautious about the "gray rhino" -- the big risk -- for the bond market: stronger
regulation.
     "I read an article today written by Wen Xinxiang, the Secretary General of
the People's Bank of China monetary policy committee, saying that the PBOC needs
to avoid providing excess liquidity just to benefit a few institutions or
product lines," the Beijing-based trader said. "That means the PBOC's risk
tolerance level has increased."
     "Especially considering there are relatively few articles from the PBOC or
other official media to pacify the market, I'm wondering if this is a sign that
stronger regulation is about to come back," the trader warned.
     The PBOC injected a net CNY110 billion in liquidity via reverse repos this
week, along with a net CNY112 via its Medium-term Lending Facility, resulting in
a total injection of CNY222 billion. There was also speculation that the PBOC
used its Standing Lending Facility on Thursday afternoon to alleviate the tight
liquidity in the interbank market, although there was no official statement
about this.
     The yuan was last traded at 6.6765 on Friday, weaker than the 6.6668 at
closing last Friday.
--MNI Beijing Bureau; +86 10 85325998; email: he.wei@marketnews.com
--MNI Beijing Bureau; +86 (10) 8532-5998; email: vince.morkri@marketnews.com
--MNI BEIJING Bureau; +1 202-371-2121; email: john.carter@mni-news.com

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