MNI: PBOC To Reduce OMOs Further, Drain Bond Liquidity

The People's Bank of China will continue to reduce open market operations to drain excess liquidity, support key money market rates and cool appetite for long-end CGBs, economists and bank officials told MNI, as it aims to rebalance the market and avoid a flood of easing expectations.

The PBOC will likely keep withdrawing liquidity from the interbank market until the key DR001 money market rate levels with the 7-day reverse repo rate, said Wang Qing, chief macro analyst at Orient Golden Credit Rating International, adding the Bank will likely maintain minimal seven-day reverse repo and net withdrawals via outright reverse repos. Short-term rates such as DR001 have room to rise by about 10 to 15 basis points in the near term, he argued.

Ample interbank liquidity has kept the weighted average DR001 rate at a low 1.22-1.25% so far this month, while the 1-year AAA-rated interbank certificates of deposit yield has fallen below 1.5%, a record low. Both are below the central bank's 7-day reverse repo rate of 1.4%.

Market participants are increasingly concerned that persistently low borrowing rates and abundant liquidity could trigger policy intervention and shift the central bank's easing stance.

The PBOC net withdrew CNY100 billion through six-month outright reverse repos last week, marking a second consecutive monthly reduction in rollovers for that tenor. Earlier in April, three-month outright reverse repos were cut by CNY300 billion. In addition, the bank has conducted CNY500 million to CNY1 billion in seven-day reverse repos on several consecutive days this month.

Wang said the continued liquidity withdrawal does not signal a shift away from an ample liquidity stance, but is intended to prevent market rates from falling too far below the policy rate. (See MNI: Energy Price Jump To Restrain, Not End PBOC Easing Bias)

EXCESSIVE LOOSENING

Dong Ximiao, chief researcher at Merchants Union Consumer Finance, noted the PBOC’s daily OMO statements stressed it had "fully met the needs of primary dealers,” suggesting the reductions reflect weaker demand rather than a tightening bias. The aim is to avoid one-sided expectations of excessive easing, he said.

A commercial bank official told MNI that monetary policy tools have become less attractive as their rates are higher than interbank certificates of deposit. With deposit growth outpacing loan growth in Q1, liability pressures have eased, prompting large banks to increase interbank lending. Funding conditions are likely to remain favourable through April and May, he added.

According to the PBOC, bank deposits rose by CNY740 billion y/y in Q1, while loans fell by CNY1.18 trillion. In March, deposits increased by CNY220 billion y/y, while loans declined by CNY650 billion.

Dong added that ample liquidity also reflects strong earlier injections, with the PBOC supplying a net CNY2.05 trillion of medium- to long-term liquidity in January and February, CNY745 billion more than a year earlier. Combined with weaker government bond financing, this has dampened liquidity demand, he noted. (See MNI: PBOC To Support Fiscal Efforts, Broad Easing Seen Limited)

FLAT CURVE

Short-end CGB prices fell in March as prospects of a reserve requirement ratio cut faded and inflation expectations rose. Since April, however, ample liquidity and easing inflation concerns have supported gains in long-end bonds. 

With signs of easing tensions in the Middle East, inflation expectations have moderated and long-term yields have declined in recent sessions. As short-end yields appear to have bottomed out, the CGB yield curve may flatten further in the near term, Wang said. In recent years, the PBOC has closely monitored long-term yields, which were linked to its earlier government bond trading operations. As a result, movements in the long end are likely to influence its liquidity management, Wang added.

The bank official said the market is seeing a typical curve-flattening trade, with funds shifting from the crowded short- and medium-term segments to the ultra-long end. Short-dated coupon bonds offer limited returns, leaving investors little option but to extend duration.

The 30-year government bond yield has fallen by 10bp this month to 2.27%, while the one-year is down about 2bp to 1.21%, reversing earlier steepening.

Wang said higher oil prices are likely to push up costs in crude and petrochemical supply chains, but overall inflation pressures should remain moderate. The 10-year CGB yield is expected to trend lower, moving into a 1.60-1.70% range from above 1.70% currently.