REPEAT: MNI China Money Week: New Year Hangover Hits Bond Ylds

Repeats Story Initially Transmitted at 08:01 GMT Jan 5/03:01 EST Jan 5

--Short-Term Bond Outlook Positive, Longer-Term Outlook Cautious

     BEIJING (MNI)   - The Chinese bond market stumbled at the start of the new

year, with long-term bond yields rising sharply, due mainly to short-term

technical issues and continued regulatory concerns.

     Analysts predicted that bonds could rally in the first quarter due to

fundamental supply and demand factors, though they cautioned that the

longer-term outlook remains bearish. 

     --BOND DIVE

     The yield on the most-actively-traded 10-year China government bond rose to

3.9325% on Thursday, up 5.25 basis points from last Friday, while that on the

most-traded China Development Bank 10-year bond rose to 4.9425%, up 13.25 basis

points from a week earlier. The rise in the CDB yield was the largest since the

end of November.

     The price of Chinese government bond forwards maturing in March also

declined sharply, with the five-year dropping to 96.25 from 96.605 the previous

Friday and the 10-year to 92.465 from 93.165. 

     The deterioration in the bond market came despite very good liquidity

conditions this week. The benchmark seven-day deposit repo (drepo), reflecting

the borrowing costs of banks, averaged 2.732% this week through Thursday, the

lowest since April last year. The seven-day repo, reflecting the borrowing costs

of all financial institutions, averaged 3.0152% this week through Thursday, the

lowest since early July.

     "Although liquidity has been pretty loose recently, the bond market is

still in a cautious mood," a Beijing-based bond trader at an asset management

company said. "The concern that liquidity will be tightened again and the fear

of stronger regulation are both preventing investors from purchasing bonds."

     --NEW YEAR'S HANGOVER

     There were three main reasons for the bond market decline this past week.

     First, preliminary economic data for December was quite strong against

market expectations for a gradual easing in growth. The Caixin Manufacturing and

Services PMIs rose to 51.5 and 53.9, respectively, much higher than market

expectations.

     Second, the intentional delay in necessary position adjustments by

financial institutions until after the end of the year likely caused intense

selling pressure in the first week of January.

     "As Dec. 31 is the date when financial institutions must record the

performance of their investment portfolios, some may not have wanted to sell

large quantities of bonds [before that date] as that would have reduced bond

prices and caused the value of their portfolios to fall, especially when the

bond market is quite weak," Ming Ming, an analyst at CITIC Securities, said in a

research note on Tuesday. "So postponed selling pressure caused bond market

yields to rise in the first week of 2018."

     Third, the Chinese Development Bank restarted its issuance of 10-year bonds

on Thursday, igniting traders' interest in shorting those bonds (See Dec. 22

China Money Week: CDB's Yield Curve Push Won't Help).

     "The reopening of 10-year CDB bond issuance, along with rising stocks and

commodities, encouraged investors to sell bond forwards short," analysts at

Guotai Junan Securities said in a report on Tuesday. "As current bond market

sentiment is very weak, falling bond forwards caused bonds to fall, a

self-reinforcing process."

     Thursday's auction results confirmed the weak demand for the 10-year CDB

bonds, with the yield bid at a relatively high 4.9052%, up from 4.7063% at the

last similar auction on Nov. 14, and total bid volume at only 2.33 times total

issuance volume of the bond. The result was described by one bond trader as a

"very bad," indicating that demand for long-term bonds is still weak.

     --REGULATION ANGST

     What now worries bond traders most is the potential for stronger

regulations in the future.

     "The bond market was not very sensitive to regulatory policies before April

last year, but the escalating regulatory efforts have made bond investors really

cautious about regulators' moves," said a Shanghai-based bond trader at a

securities company. "I think the bond market will only stop falling when this

fear gradually disappears."

     But regulatory pressure shows no signs of easing. The People's Bank of

China has enacted strict limits on the issuance of negotiable certificates of

deposit (NCDs), which forced banks to sharply cut their NCD issuance last year

and is expected to do so again this year. In addition, the final version of the

regulation on asset management products is expected to come out soon, probably

this month, and the market does not expect the final version to be any less

strict than the draft published in December.

     --SHORT-TERM OPTIMISM

     However, some analysts argued there is no need to worry about the bond

market outlook in the near term. 

     "The PBOC is trying to prevent new risks through financial deleveraging, so

the regulation will not have too big impact in spooking the market in the

short-term," CITIC Securities' Ming said. "And as liquidity conditions are

likely to remain in a slightly relaxed state until the Spring Festival holiday

[which starts Feb. 16], 10-year CGB bond yields will likely fall closer to

3.80%."

     Some short-term trading opportunities also exist, according to analysts.

     "Bond market sentiment might improve as liquidity conditions get better and

the targeted required reserve ratio cut becomes effective," analysts at China

International Capital Corp. said in their research note on Thursday. 

     Under the targeted required reserve ratio cut, banks that meet minimum

levels for lending to the agricultural sector and micro- to small-sized

companies saw their reserve requirement ratios lowered by 50 basis points from

Jan. 1. Banks that meet higher lending levels for these sectors will see their

RRR cut 100 basis points.

     In addition, a "temporary required reserves usage arrangement" was

announced earlier to allow national commercial banks that suffer a temporary

liquidity crunch during the Chinese News Year season to temporarily take out and

use no more than two percentage points of their required reserves parked in the

PBOC for a period of 30 days, which will also help to alleviate any liquidity

shortages before the holiday as cash needs surge.

     "In terms of bond supply and demand, bond supply is relatively low in the

first quarter, while demand could be strong because insurance companies will

absorb a large amount of funds in the first quarter, causing demand to rise

compared with supply and so providing trading opportunities for bond investors,"

CICC said. 

     --LONGER-TERM CAUTION

     But in the longer term, bond investors should remain patient.

     "Strict regulations, a prudent and neutral monetary policy, along with

resilient fundamental economic conditions, will lead to a relatively stable bond

market in the short term, and better liquidity conditions might even lead to a

short-term rebound of the bond market," analysts at Industrial Securities wrote

in a report on Tuesday. 

     "However, as long-term funding for the banking system is still lacking, and

funding demand will not weaken dramatically because of resilient economic

conditions, the bond bear market is not over," they warned. 

--MNI BEIJING Bureau; +1 202-371-2121; email: john.carter@mni-news.com

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

--MNI Beijing Bureau; +86 (10) 8532-5998; email: vince.morkri@marketnews.com