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China Drains Funds From Banking System as Cash Crunch Eases

Bloomberg logoBloomberg 2/3/2021 Bloomberg News

(Bloomberg) -- China drained funds from the financial system after a key cost of short-term borrowing tumbled from its highest level since 2015, showing officials remain wary of excess liquidity.

The People’s Bank of China withdrew a net 80 billion yuan ($12 billion) of liquidity on Wednesday. The central bank offered just 100 billion yuan of seven-day funds even as 180 billion yuan matured. That means 480 billion yuan will now come due before the Lunar New Year holiday starts next week.

The overnight repo rate fell 37 basis points to 1.86%, in line for the lowest since Jan. 15. The rate surged to 3.3433% last month, surpassing China’s 10-year government bond yield.

chart: China's overnight money market rate drops from almost six-year high © Bloomberg China's overnight money market rate drops from almost six-year high

How China’s Liquidity Squeeze Got Markets All Rattled: QuickTake

The PBOC’s decision to withdraw cash in January rattled Chinese financial markets, sending overnight interbank borrowing costs to the highest in almost six years. It also caused investor concern that authorities were driving up money market rates as a way of tightening monetary policy to remove speculation in housing, stocks and bonds. The central bank had been adding funding since then.

The Securities Times, a national newspaper owned by the official People’s Daily, published a commentary Wednesday that said the central bank’s recent open-market operations are a sign it is seeking to keep liquidity “tightly balanced” to prevent risks stemming from leverage. State media last week ran a prominent commentary effectively telling people not to worry about the availability of funds.

“The PBOC has been closely watching asset prices, such as in the stock market,” said Ming Ming, head of fixed-income research at Citic Securities Co. “Liquidity conditions have clearly turned loose after injections since last Friday.”

He added that an unscheduled injection of medium-term liquidity before the holiday is now less likely than it was a few days ago, and the central bank is instead expected to offer a net 300 billion yuan to 500 billion yuan of funding in the coming week, mainly through reverse repos.

chart, bar chart: Liquidity Test © Bloomberg Liquidity Test

Adding to investor worries is the banking system’s mounting demand for funding due to the holiday period, which starts Feb. 11. That’s because people across the country will spend heavily on gifts and travel, even though celebrations will be muted due to the virus pandemic.

Traders are pricing in tighter funding conditions, with futures contracts on 10-year government bonds retreating by as much as 0.4% in the afternoon to the lowest in six weeks. One-year interest-rate swaps, a key indicator of investor expectations for future liquidity, climbed 5 basis points to 2.64%.

The PBOC needs to provide more than 1.5 trillion yuan of liquidity to stabilize money markets around the break, according to a Bloomberg Intelligence report by strategists including Stephen Chiu.

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