PBOC Seen Raising Money Rates Twice in 2017 to Cut Leverage

(Bloomberg) -- China's central bank will keep a tight rein on money-market rates this year, raising the cost of short-term funds at least twice in moves that will pressure bonds.

That's the consensus view in a survey of 29 fixed-income traders and analysts, with 20 saying that the People's Bank of China will increase open-market operation rates by 10 basis points in the second quarter itself. Government bonds will decline for the third quarter in a row in the April-June period, according to the March 24-27 poll. That would be the longest run of losses in six years.

China's policy makers are walking a fine line between driving money rates higher to reduce leverage in the financial system and preventing a cash crunch. They have already raised the cost of reverse-repurchase agreements twice this year, while benchmark interest rates have been on hold since 2015. A separate survey predicted that the PBOC will keep both benchmark borrowing costs and bank reserve-requirement ratios unchanged throughout the year.

“China is far from the end of efforts to squeeze out bubbles in the financial system,” said David Qu, a Shanghai-based markets economist at Australia & New Zealand Banking Group Ltd. “The PBOC will to some extent follow the Federal Reserve in tightening to keep the rate gap largely steady.”

The overnight repo rate on the Shanghai Stock Exchange jumped as much as 21.67 percentage points to 32 percent, the highest level since Dec. 27. The benchmark Shanghai Composite Index declined 1 percent.

The PBOC kicked off its latest tightening cycle in August after broad monetary loosening helped fuel an unprecedented, 11-quarter bond rally. The central bank resorted to injecting longer-term funds in open-market operations, and raising the cost of loans to commercial lenders. On March 16, while explaining the rationale for its latest open-market borrowing cost increase after a Fed hike, the PBOC said higher rates would help offset a drop in real interest rates and maintain a yield advantage over the U.S.

Taming Credit

PBOC Governor Zhou Xiaochuan told reporters during the National People's Congress earlier this month that taming the credit binge will be a “medium-term process.” At the Boao forum held over the weekend, he said one of the priorities in China's structural reforms in the short- and medium-term is lowering leverage.

“The funding market will become more volatile in the second quarter and there will be more frequent hiccups,” said Yan Yan, the Shanghai-based head of fixed income trading at China Guangfa Bank Co. “The pivotal level of funding costs will rise further.”

The survey's results suggest that:

• The seven-day repurchase rate, a gauge of interbank funding availability, will average 2.70 percent in the April-June period, compared with 2.61 percent so far this year. The rate closed at 2.81 percent on Thursday.
• The 10-year sovereign bond yield will end the second quarter at 3.4 percent, according to the median estimate. That compares with a yield of 3.27 percent on Wednesday.
• Nine respondents forecast that the sovereign yield curve will bear steepen, while eight expect rangebound trade and seven see a bear flattening.
• The PBOC will boost the costs of funds offered in reverse-repurchase operations, according to all but two of the 29 respondents.
• The credit premium of five-year AA grade corporate bonds over top-rated peers will widen by as much as 50 basis points, according to 18 respondents. The gap was last at 49 basis points, the narrowest since at least 2010.
• The participants in the Bloomberg survey included China Guangfa Bank Co., Hengfeng Bank Co., Genial Flow Asset Management Co., Mao Dian Asset Management, JD Finance, Tebon Securities Co., SDIC Essence Futures Co. and Nanhua Futures Co. Twenty-one traders and analysts asked not to be identified as they are not allowed to comment on the matter publicly.

--With assistance from Yuling Yang Shuqin Ding Ling Zeng and Yinan Zhao

To contact Bloomberg News staff for this story: Helen Sun in Shanghai at hsun30@bloomberg.net, Jing Zhao in Beijing at jzhao231@bloomberg.net, Xize Kang in Beijing at xkang7@bloomberg.net.

To contact the editors responsible for this story: Richard Frost at rfrost4@bloomberg.net, Robin Ganguly, Jeff Kearns

With assistance from Helen Sun, Jing Zhao, Xize Kang