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China Averts Cash Squeeze That Was Wreaking Havoc on Bonds

Bloomberg News
·3 min read

(Bloomberg) -- China’s central bank has pumped enough cash into the banking system to convince government bond investors that the worst is finally over.

Over the past month, the People’s Bank of China has had to work especially hard to rein in borrowing costs after a surge in credit defaults damped commercial lenders’ enthusiasm to make loans. The central bank injected a net $84 billion in one-year funding and $20 billion of short-term cash into the financial system in the final five weeks of 2020 alone.

The PBOC is likely to maintain sufficient liquidity around the Lunar New Year holiday in mid-February, when demand for cash is typically high. Policy makers vowed this month there would be no hasty reversal of monetary easing, saying China’s economic recovery wasn’t yet solid enough. The assurance came after Beijing signaled it will unwind some of the stimulus measures put in place to support growth during the pandemic in an effort to stabilize the record amount of leverage in the economy.

The injections have helped calm money markets and arrest the longest selloff in government debt since 2007. Interest rates on short-term interbank debt have fallen to a five-month low, and an indicator showing traders’ bets on borrowing costs is set for the largest monthly decline since April.

Here are four charts reflecting easing liquidity concerns:

China’s bond traders are finally taking a breather from a sustained selloff. The yield on 10-year sovereign notes has fallen 13 basis points in December, snapping a seven-month rising string and poised for the biggest decline since March.​ The country will ensure “reasonable and ample liquidity,” maintain “necessary support” for economic recovery, and further reduce lending rates for companies, according to a PBOC statement Tuesday.

“When should you buy government bonds? Right now,” Guotai Junan Securities Co. analysts including Qin Han wrote in a note. The PBOC has sent enough signals to show that a “mini easing cycle” has arrived, they said, adding that “borrowing costs will fluctuate at low levels, which helps create good conditions to add leverage.”

The cost for banks to borrow from each other has dropped, reflecting easing funding pressure. The yield on three-month negotiable certificates of deposits sold by AAA rated lenders has declined 55 basis points so far this month, on pace to snap a seven-month rising streak. The overnight repurchase rate, a gauge of short-term interbank borrowing costs, is near the lowest level on record.

The stockpile of idle funds at banks has also rebounded, meaning they now have more cash to invest in bonds. The excess reserve ratio at local lenders rose to 1.63% in November, the highest in five months, according to estimates by China Merchants Securities Co.

Traders expect borrowing costs to fall even further. The cost on one-year interest-rate swaps -- a gauge of investor’s bets for future money-market rates -- is set for the biggest monthly drop since April.

(Updates short-term cash injection amount in the second paragraph and month-to-date drop in bond yield in the sixth paragraph.)

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