0732 GMT November 20, 2018
Faced with a slowing economy and the risk of trade-war fallout, the People’s Bank of China has turned on the liquidity taps. To borrow yuan overnight in the onshore market, the annualized charge is 1.58 percent, the least since 2015. For smaller banks needing to sell negotiable certificates of deposit, yields are at record-lows. Currency forwards, interbank borrowing costs, government bonds and interest-rate swaps show a similar picture, according to Bloomberg.
There are signs that local traders are seizing on the funding, with the volume of overnight repurchase agreements rising to a record in July. And it’s a great window for foreign investors to take hedged positions in Chinese bonds, said JPMorgan Asset Management. But with the yuan in the spotlight, Chinese officials now face a trade-off between keeping liquidity flush and helping to support one of the world’s worst-performing currencies.
"Excessive domestic liquidity would lead to depreciation," said Ming Ming, Beijing-based head of fixed income research at Citic Securities Co. "With China-US monetary policy divergence in the backdrop, the yuan could see more pressure in the future."
Funding costs for lenders have tumbled, as the PBOC keeps liquidity ample. The overnight Shanghai Interbank Offered Rate has dropped to lowest since August 2015, while the yield of three-month AAA-rated negotiable certificates of deposit — a lifeline for small and medium banks — has slid to the lowest level in nearly three years.
The yuan’s swap points, an indicator of the currency’s funding costs in onshore foreign-exchange market, are close to the lowest level in seven years. The cost to hedge exchange rate risk has ‘cheapened dramatically’ for foreign investors, said Jason Pang, Hong Kong-based portfolio manager at JPMorgan Asset Management. Buying onshore Chinese sovereign bonds has become ‘more interesting’ as it offers a similar yield to US Treasuries.
"As China eases monetary policy to support the economy and combat the trade war, that’s a more constructive backdrop for government bonds than the monetary policy tightening cycle currently underway in the US," he said.
Domestic investors are effectively adding leverage again to buy bonds, as cash becomes cheaper in the authorities’ push to invigorate the economy. The change in investors’ behavior has driven the volume of pledged overnight repo trading to a record high in July, while the overnight repo rate fell to the lowest level since August 2015.
The yield gap between government and AAA-rated corporate debt has narrowed to the lowest since November 2016, as a more accommodating monetary policy eases credit risk concerns, boosting appetite for riskier bonds again.
Yuan one-year interest rate swaps are trading near their lowest level since October 2016, signaling expectations that liquidity will remain ample for a while. However, the central bank’s hands may be tied when it comes to any further easing ambitions, given the risk of placing further pressure on the yuan.