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Central bank operations highlight efforts to cool the bond market

People’s Bank of China increasingly resorting to more cautious ways of injecting cash into the financial system

PUBLISHED : Tuesday, 20 September, 2016, 12:17pm
UPDATED : Tuesday, 20 September, 2016, 10:08pm

The Chinese central bank’s recent open market operations are being widely viewed as a sign of continued efforts to reduce leverage and curb speculation to cool down a red-hot bond market.

They also mean further monetary easing is less likely as the central bank is increasingly resorting to more cautious ways of injecting cash into the financial system.

The People’s Bank of China (PBOC) conducted 120 billion yuan of 28-day reverse repurchase

agreements (known as repos) on Monday, a process in which it buys securities from commercial banks with an agreement to resell them in future as a way of pumping temporary money into the market.

That’s was the third consecutive day the central bank has conducted the operation, after 65 billion yuan of 28-day repos last Wednesday and 60 billion yuan the day before, prior to the mid-autumn holiday, when the PBOC restarted such operations for the first time since February.

The 28-day repos are being conducted after the central bank restarted 14-day repos last month.

Since mid-August, it has been decreasing the amount of the cheaper 7-day repos that it makes to commercial banks in its daily money-market operations, and replacing those with pricier 14-day repos.

The operations are unusual, as it’s the first time in four years the central bank has resorted to the 28-day and 14-day repos in the middle of the year, as a way of pumping liquidity into the market.

They are usually used before China’s lunar new year, for instance, to ease cash strains during the country’s most important holiday. At other times, overnight and seven-day repos are used to adjust liquidity in the market.

And analysts now believe all these central bank moves are aimed at tightening short-term liquidity and deleveraging a bullish bond market.

“The PBOC has been increasing borrowing costs by reducing the amount of cheap, short-term credit available in the financial system and increasing pricier long-term ones, which force financial institutions to reduce leverage,” said Ming Ming, the chief fixed-income strategist at CITIC Securities in Beijing.

The PBOC has been increasing borrowing costs by reducing the amount of cheap, short-term credit available in the financial system and increasing pricier long-term ones, which force financial institutions to reduce leverage
Ming Ming, the chief fixed-income strategist at CITIC Securities in Beijing

In China’s money market, short-term loans are usually used to satisfy the daily cash needs of financial institutions. Banks have increasingly lent that money to investors, who borrowed it at cheap rates to plough into assets such as bonds.

The PBOC seems to be increasingly concerned about the risk of bubbles forming in the bond market and the recent changes in its open market operations clearly show its intention to reduce both leverage and speculation.

Three years ago, the bank actually moved to squeeze the amount of cash in the financial system by pushing short-term rates up to 30 per cent, in an effort to curb risky lending practises. But that in turn created a panic about a liquidity shortage.

This time around, it has resorted to more subtle ways of forcing banks away from overnight and 7-day repos, and has increased 14- and 28-day operations to inject cash into the financial system to avoid a cash crunch.

Meanwhile, after several interest rate and RRR (required reserve ratio) cuts last year, the recent open market operations show the central bank is getting increasingly cautious over monetary easing as their effectiveness to stimulate the economy is diminishing, but those also bring the risks of asset bubbles.

According to a research note from the CIB Research, despite a cash strain in the overnight inter-bank market, the central bank refrained from large-scale injections, but extended the tenor of reverse repurchases instead, reducing market expectations for monetary loosening.

“The open market operations are being used more frequently, to a great extent replacing interest rate cuts and RRR cuts,” said Ming.

A research note from the Shenwan Hongyuan Securities, adds that injecting liquidity through repos more frequently has made a RRR cuts less possible and less necessary in the short term.

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