REPEAT:MNI China Money Week: PBOC's Zhou Jolts Bond Market

Repeats Story Initially Transmitted at 08:01 GMT Oct 20/04:01 EST Oct 20

     BEIJING (MNI) - People's Bank of China Governor Zhou Xiaochuan sent the

bond market into a mini panic this week, causing yields to surge after

forecasting the country's economy could grow by as much as 7% in the second half

of the year. 

     His comments, made at the International Monetary Fund's autumn meetings in

Washington over the weekend, came days before the National Bureau of Statistics

(NBS) was due to announce third-quarter gross domestic product numbers. The

market was expecting a marginal slowdown in GDP growth to 6.8% year on year

after a 6.9% gain in the first two quarters, so the governor's estimate ahead of

the Oct. 19 data release came as a shock. 

     Zhou's comments had a dramatic effect on sentiment, triggering concern that

accelerating GDP growth may lead to higher interest rates and stronger inflation

and pushing 10-year government bond yields above 3.7% for the first time since

April 9, 2015.

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

maturing on Aug. 3, 2027, jumped from 3.6725% last Friday to 3.7450% on

Wednesday, surging past the 3.7% level that many traders and analysts had seen

as unbreakable.

     "The bond market got very worried about the economic data," a Beijing-based

bond trader at a commercial bank said. "What Zhou said led to an about-face in

the market's expectations for a slowdown in growth, and that really hurt bond

investor sentiment."

     Zhou's comments overshadowed a good week for interbank market liquidity,

with the PBOC showing unusual generosity in offering funding, in an effort to

keep liquidity and money-market interest rates stable as the ruling Communist

Party opened its 19th Party Congress, a week-long meeting of the leadership that

is expected to see the retirement of many top officials and consolidate the

power of Xi Jinping, the country's president and head of the party. 

     The benchmark seven-day deposit repo rate, which reflects interbank

borrowing costs for banks, averaged 2.8704% this week, compared with 2.9056%

last week. The seven-day repo rate, which reflects borrowing costs for all

financial institutions, averaged 3.1419%, compared with 3.3618% last week.

     The CFETS-ICAP money market sentiment index averaged 42.6 this week, lower

than 50.9 last week.

     The PBOC injected a total of CNY560 billion via open-market operations this

week. A total of CNY439.5 billion of Medium-term Lending Facility loans expired

last week and this week, but they were more than covered by a new injection of

CNY498 billion in MLF loans last Friday. 

     "Liquidity was abundant, and the PBOC's large injection has set the tone

for relatively relaxed conditions this month," an interbank trader at a rural

commercial bank said on Wednesday. "I don't think we'll see a turning point for

liquidity until November."

     Some traders said there were signals that bond yields would have risen this

week even without Zhou's comments, as investors stayed on the sidelines. 

     "If you look at 10-year government bond yields last week, you can see that

yields were already going up in spite of relatively good liquidity conditions,"

another Beijing-based bond trader at a commercial bank said. "When there is no

more good news coming and bond yields are still not going down, then they are

more than likely to go up."

     Stop-loss strategies by market participants also caused bond yields to

rise, analysts said. 

     "In September, some non-bank financial institutions increased their

purchases of bonds driven by the weak economic data in August," Chen Jianheng,

an analyst at China International Capital Corp., said in a report on Tuesday.

"But the stop-loss mechanism forced them to sell when yields rose, causing

yields to go up further."

     Tang Yue and Huang Weiping, analysts at Industrial Securities, pointed out

in their report on Thursday that the main short-term to medium-term bond

investors are small and medium-sized banks and non-bank financial institutions,

whose liquidity pressures are high and liabilities structure unstable because

they cannot attract the same sort of large deposits as big banks do, so they

will quickly sell when bond prices go down because they fear further price drops

would lead to even greater losses.

     Market concerns reached a peak just before the GDP data release on Thursday

morning, with some speculating that third-quarter growth could be as high as

7.3%. When the number was finally released, bang in line with market estimates

of 6.8%, relief flooded the bond market. The yield on the most-traded 10-year

CGB immediately dropped from 3.7175% to 3.70%, although it later rebounded to

3.7125%.

     "The third-quarter GDP data eliminated the panic in the bond market that

the economy was growing so rapidly," Ming Ming, a bond analyst at CITIC

Securities, said after the release. "In the short term, this could be good news

for the bond market."

     "Although GDP growth remained stable, the business cycle has peaked and is

now entering a contraction," Song Xuetao, a macro-economy analyst at Tianfeng

Securities, said on Thursday. "Long-term bonds are not going to trade at high

yields for much longer. 

     "Any event that pushes bond yields higher is an opportunity to buy," he

said. 

     However, the prospect of tighter financial regulations dropped a big fly

into the ointment.

     On Thursday morning, Guo Shuqing, the head of the China Banking Regulatory

Commission, said the campaign to crack down on irregularities in financial

markets will continue and financial regulators will tighten oversight of the

markets. His words sent a chill through the market, preventing a further slide

in bonds yields triggered by the GDP data. 

     "Bond investors are still quite cautious. Even when the GDP turned out to

be more favorable for bond investors than expected, bond yields did not slide a

lot," the first Beijing trader said. "The market still fears the impact of

strong financial regulations."

     Huang Wentao and Zheng Lingyi, bonds/fixed-income analysts at China

Securities Co., said Thursday that "The emphasis of government policy will still

be on supply-side reform and preventing financial risk, and the main theme will

continue to be one of a neutral monetary policy stance and strong financial

regulation."

     "Considering that a series of new regulatory policies will be enacted and

implemented in the future, bond yields probably won't fall significantly," they

said.

     The key deciding factor for the direction of the bond market will be

economic conditions. 

     "Investors need to pay close attention to whether the economic slowdown is

worse than expected," Huang and Zheng said. "That's what will lead to a

relaxation of monetary policy and financial regulation" that will benefit the

bond market.

     The yuan weakened this week and last traded at 6.6210 versus the dollar on

Friday, compared with 6.5868 last Friday.

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

--MNI Beijing Bureau; +44 203-586-2244; email: nerys.avery@marketnews.com

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