PBOC cash injection signals leverage, asset bubble concerns

Shanghai

CHINA'S central bank injected cash into money markets through 14-day reverse bond repurchase agreements (repos) for the first time since February in a sign that policymakers were worried that rising leverage could stoke bubbles in the bond market.

Analysts said that the switch to longer tenor, higher interest rate injections may signal that the central bank is concerned that too much of short-term borrowing is flowing into the bond market. For most of 2016, the People's Bank of China (PBOC) has effectively targeted the lower interest seven-day rate, with cash injections nearly every day.

The PBOC on Wednesday injected 90 billion yuan (S$18.3 billion) into money markets through seven-day repos and an additional 50 billion yuan through 14-day reverse repos on Wednesday, traders said. "The PBOC appears to be signalling to banks to move away from a reliance on short-term liquidity and head towards more longer term liquidity," wrote Jonas Short, Head of NSBO Policy Research in Beijing in a note on Wednesday.

The major worry for policymakers, some analysts said, is that rising repo leverage and the over-reliance of smaller banks on short-term liquidity threatened asset price bubbles in the debt market, and added to systemic banking sector risks.

"The market read this (the 14-day queries) as the signal that PBOC may want to curb leverage in bond market as funding cost from 14-day reverse repo is higher than from seven-day and overnight reverse repo, which may increase costs for leverage," wrote analysts from OCBC Bank in Singapore Wednesday. "The recent rally in bonds fuelled by leverage on the back of stable short-end funding raise concerns about potential asset bubble risks in China's bond market."

Indeed, Chinese debt has sold off over the past week as doubts on further broad-based monetary easing have risen and investors took profit following a sharp rally in onshore bonds, which pushed the 10-year Chinese treasury to seven-year lows in mid August.

The market reaction was swift, with the volume weighted seven-day rate, considered the best general indicator of liquidity in China trading at 2.5 per cent by mid afternoon Wednesday, up 10 basis points (bps) from Tuesday's closing average rate.

Analysts suggested that small banks could bear the brunt if short-term liquidity remains tight. "Overall, small banks are likely to continue to struggle should short-term interbank rates continue rising as the double whammy of a high interbank borrowing rate coupled with tightening on issuing financial products suggests there may be potential for a liquidity squeeze for small banks on the horizon," said NSBO Policy Research's Mr Short.

In fact, after the news broke on Tuesday that the central bank was querying banks on demand for two-week repos, the benchmark seven-day repo rate notched its highest close since January at 3.24 per cent.

"Cash is extraordinarily tight today, you're seeing the seven-day hanging around 2.8 per cent, you can't get 14-days and people are being pushed into the 21-day," said a trader at a Chinese bank.

With the central bank's move to 14-day reverse repos for the first time since February, some in the market took it as a signal that further cuts to bank required reserve ratios were unlikely.

Chinese treasury futures promptly sold off on the news, with the price of the 10-year future for December delivery falling 0.38 per cent, the biggest move downward in over three months. REUTERS