PBOC Pause in Easing Seen Extended in Quarter on Inflation Risk

  • Just two of 19 analysts surveyed see cut in reverse-repo rate
  • Growth stabilizing, inflation `cloud' bond market's outlook

China’s central bank will probably extend a pause in monetary easing to avoid adding fuel to inflation, even as it risks derailing a record bond rally.

Of 19 traders and analysts surveyed by Bloomberg, only two forecast the People’s Bank of China will cut its seven-day reverse-repurchase rate this quarter, while the rest predict no change at 2.25 percent. Eight said an improving economy will be the most negative factor for the bond market, while seven flagged the risk of rising consumer prices, according to a survey conducted Tuesday and Wednesday.

A report due next week will probably show inflation accelerated to 2.4 percent in March amid rising food and housing prices, threatening to undermine a bond rally that has stretched for nine straight quarters. The PBOC is moving toward using the interest rate of its open-market operations as its new benchmark after scrapping a cap on deposit rates last year.

“The stabilizing economy and rising inflation will be the two most important factors that will cloud the performance of the bond market,” said Yan Yan, a Shanghai-based trader at China Guangfa Bank Co. “Current yields are already very low, and the market isn’t confident enough that the bull run will continue.”

The central bank last lowered the interest rate in its open-market operations in October, when it also cut its benchmark deposit and lending rates for the sixth time in less than 12 months. It has kept the reverse repo rate offered at 2.25 percent since then, while the rate traded between banks has averaged 2.32 percent.

Lower short-term funding costs and the slowest economic expansion in a quarter century have prompted local investors to borrow money to amplify their returns, driving repo transactions -- a rough gauge of leverage -- to a record in December. All that borrowed money helped push the benchmark 10-year sovereign yield to a seven-year low in January, and narrowed the yield premium of five-year AA corporate notes over government debt to the least since at least 2010.

“If the PBOC cuts the reverse repo rate again, leading to more declines in short-term funding costs, it’ll encourage institutions to further add leverage,” Yan said. “This is probably not something market regulators want to see.”

Leverage Issue

The China Securities Depository and Clearing Corp. has surveyed some brokerages on the use of leveraged investments in the exchange-traded bond market, people familiar with the matter said in December. Regulators also sent questionnaires to fund management companies to seek information on their outstanding repo positions, the Securities Times reported on March 28, without citing anyone.

Adding to the pressure on the bond market are increasing signs that the economy has bottomed out. The manufacturing Purchasing Managers’ Index for March unexpectedly rose above 50, the dividing line between expansion and contraction, for the first time since June, while industrial profits in the January-February period snapped a seven-month losing streak. A property market recovery also accelerated in February, with prices rising in the most cities since March 2014. Data to be released next week may show new yuan loans in March exceeded 1 trillion yuan ($155 billion).

The 10-year sovereign yield has rebounded 18 basis points after hitting the low in January, and was at 2.9 percent on Thursday, ChinaBond data show. The lower end of the trading range in the second quarter will be 2.8 percent, and the upper end 3 percent, according to the median estimate of this week’s survey.

Swaps Climb

The Ministry of Finance issued 10-year bonds at 2.86 percent on Wednesday, the highest yield since December. The yield on government notes due January 2026 rose six basis points this week to 2.90 percent, according to National Interbank Funding Center prices. That’s the biggest weekly increase since January, ChinaBond data show.

The cost of one-year interest-rate swaps, the fixed payment to receive the floating seven-day repo rate, climbed three basis points this week to 2.35 percent, according to data compiled by Bloomberg. That’s the biggest weekly gain in more than two months.

“There’s a strong expectation that the economy will stabilize in the short term, so bond yields are likely to climb in the second quarter,” said Wan Zhao, a senior analyst at China Merchants Bank Co. “The market will be under bigger pressure from inflation and increases in asset prices, so it will probably prevent further monetary easing, though certainly it’s not yet time to tighten.”

— With assistance by Yuling Yang, Xize Kang, Ling Zeng, and Helen Sun

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