MNI: PBOC To Expand Tools, Cut RRR As Fresh Bonds Hit Market

The People’ s Bank of China is likely to expand the recently introduced outright reverse repo tool, up its bond trades and make further cuts to the reserve requirement ratio later this year as it prepares to offset any potential liquidity shock driven by increased local government special bond issuance, policy advisors and traders told MNI.

 

The significant supply and long maturity of the new bonds, combined with financial institutions' strong demand for year-end liquidity and profit taking, will likely drive long-term yield fluctuations, said Cao Jing, associate research fellow at the Institute of Finance & Banking at the Chinese Academy of Social Science, pointing to the Ministry of Finance’s CNY6 trillion plan unveiled this month to swap out "hidden" local government debt over the next three years. 

 

While the Ministry’s plan could see as much as CNY2 trillion of fresh bonds hit China’s fixed-income market over November and December, the PBOC will likely increase its secondary-market treasury purchases to stabilise volatility or cut the RRR by 25-50 basis points, Cao noted. (See MNI: More RRR Cuts Would Pave Way For China Bond Sales-Advisors)

 

The central bank has adopted various measures to enrich its open market operations this year, purchasing a net CNY500 billion in treasuries by the end of October after it introduced bond trading in August. It also launched the outright reverse repo tool last month with a CNY500 billion operation. (See MNI BRIEF: PBOC Launches Outright Reverse Repo For Liquidity)

 

The scope of the PBOC’s outright reverse repo – which includes treasuries, local government, financial and corporate bonds – can mitigate market disruptions caused by short-term, large-scale local government debt issuance, in addition to its more direct influence on treasury yields, said Yang Juan, senior researcher at Bank of China.

 

A policy advisor told MNI the PBOC could also conduct temporary or reverse repo between 4pm and 4:20pm on trading days – a tool revealed in July, but not yet used – to maintain interbank liquidity conditions at reasonable and ample levels.

 

 

Long-dated China treasury yields have risen rapidly over the last week as investors grow concerned over increased supply. The spread between the 30- and 10-year bonds has widened 7bp since September to 19bp, while the difference between the 30- and 7-year treasuries has increased to 34bp from 27bp.

 

Investors are also worried about the skew towards longer 10-year plus maturities, which is unlike past supply shocks, a bond trader at a state-owned bank told MNI. Henan province’s 10-year issuance last Friday, with proceeds used to swap existing hidden debt, came with higher-than-expected yields, reigniting market concerns about supply and leading to a rebound in long-term bond yields on Monday, he added.

 

However, the PBOC’s deft liquidity and money-market rate management meant extreme liquidity shortages were rare this year, he insisted, predicting the 10-year treasury yield would cap at 2.15% from 2.09%, while the 30-year would top out at 2.35% from 2.3%. The 10-year treasury yield would fall to 1.8% next year, he added.

 

Authorities will find issuing all CNY2 trillion in such a short amount of time difficult, which will naturally limit the supply shock, the advisor argued.

 

 

More time is needed to validate the economic recovery, the advisor noted. Whether bond yields have reached a stage of significant upward momentum remains difficult to ascertain while monetary policy remains accommodative, he argued, noting the current additional stimulus will stall after two quarters. The bond market will continue to rally should Beijing delay further fiscal support, or it falls short of expectations, he added.

 

Yang estimated short-term treasury yields will decline further and the yield curve will flatten in future.

 

The PBOC and state lenders since Q3 have sold long-term treasuries and bought short-term bonds to maintain a steep yield curve and manage interest rates across different maturities.