China's Latest Liquidity Mystery Sees Bond Market Awash in Cash

  • Benchmark seven-day repurchase rate trades near April low
  • PBOC attitude to be tested later in July amid MLF maturities

For most of this year, China’s bond traders have been grappling with a liquidity squeeze. Now they’re facing the opposite situation.

The benchmark seven-day repurchase rate is trading near the lowest level since April, even as the central bank refrained from injecting funds into the financial system for a 10th straight day. Theories on why this is happening include a seasonal pattern in which money rates tend to fall in July, speculation a reported curb on loan issuance is keeping banks flush with cash, and an increasing willingness among Chinese corporations to convert foreign currency holdings into a strengthening yuan.

Looser interbank liquidity is offering better prospects for a bond market rebound after three consecutive quarters of losses, the longest run in nearly a decade. Still, it remains to be seen whether the People’s Bank of China judges this as a threat to the deleveraging campaign and what it plans to do in response.

“It’s a mystery to us,” said Yan Yan, a Shanghai-based analyst at China Guangfa Bank Co. “We know liquidity tends to improve after end-June, but this time it’s much looser than people had expected.”

The seven-day repo rate, a gauge of interbank funding availability, rose two basis points to 2.73 percent at 5:40 p.m. in Shanghai after falling for the previous four days, according to weighted average prices. The yield on 10-year sovereign bonds declined one basis point to 3.58 percent after hitting a nearly one-month high of 3.61 percent on July 4, data compiled by Bloomberg show.

The PBOC said liquidity in the banking system is “at a relatively high level” and “ample” in four statements it issued this week announcing it would refrain from conducting open-market operations. Conditions tend to loosen in July after quarter-end tightening in June.

These conditions could also be due to bank loan curbs, or because a strengthening yuan is prompting companies to step up foreign currency settlements, Yan said. “But these are all guesses; it’s not all clear,” he said.

China’s central bank ordered the nation’s lenders to strictly control new loans earlier in the year, people familiar with the matter said at the time. Aggregate financing fell in May to the lowest since October, with June figures due next week.

The onshore yuan strengthened against the U.S. dollar for two consecutive quarters this year, the first back-to-back gains since 2014. The exchange rate rose 1.5 percent in the three months ended June 31, the most since 2010, amid suspected intervention. The currency was little changed at 6.8036 per dollar Thursday.

The central bank skipped open-market operations for a tenth consecutive day Thursday, the longest run since a 13-day period beginning in late March. Weighing in maturities, that resulted in an effective drain of 730 billion yuan ($107.3 billion) from the financial system since June 21, data compiled by Bloomberg show. Some 357.5 billion yuan of Medium-term Lending Facility loans will come due in the next three weeks.

— With assistance by Helen Sun

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