China Cash Shortages Push Up Funding Costs, Pressuring Bonds

As a wave of global liquidity pushes assets ever higher, in China the opposite is occurring. Borrowing costs in the world’s second-largest economy are spiking, driving down bonds and stocks, as the central bank holds back on aggressive easing.

While the People’s Bank of China has stepped up actions to mitigate the liquidity shortage, injecting the most funds this month since January, that’s done little to alleviate the relative drought. A gauge of interbank borrowing costs is close to a six-month high and an indicator of liquidity tightness in the foreign-exchange market has touched its highest level since 2017. The yield on 10-year government debt is above 3%, approaching a record gap with Treasuries, while the Shanghai stock benchmark has fallen below its 30-day moving average. The yuan is at its highest level since January.

Banks in particular are suffering. They were compelled to invest in 1.1 trillion yuan ($160 billion) government bond issuance to help rebuild the economy in the wake of the multi-month shutdown, while more than 700 billion yuan of policy loans mature this month. As a result, banks are hoarding cash and charging higher lending rates to each other. With even more policy loans expiring next month, and a strengthening economy reducing the need for easing, the tightness is expected to continue.

“China has been cautious in its liquidity injections, so while banks can still secure funding, the borrowing costs aren’t cheap,” said Becky Liu, head of China macro strategy at Standard Chartered Bank Ltd. “Some traders even worry the central bank may tighten monetary policy.”

Here’s a look at the indicators reflecting tight liquidity:

China Cash Shortages Push Up Funding Costs, Pressuring Bonds

Lenders are requesting higher interest rates as they loan out their cash to peers. The seven-day repurchase rate, the benchmark indicator of interbank borrowing costs, rose to the highest level in nearly half a year last week and has stayed elevated since then.

China Cash Shortages Push Up Funding Costs, Pressuring Bonds

Lenders parked the smallest share of idle money at the People’s Bank of China last month since February 2018, suggesting they were grappling with dwindling cash buffers, according to estimates by China Merchants Securities Co.

China Cash Shortages Push Up Funding Costs, Pressuring Bonds

The tightness isn’t limited to the money market. The offshore yuan’s 12-month forward points, a gauge of the currency’s funding costs relative to those on the dollar, climbed to the highest level since 2017 this month. That indicated liquidity was scarce in the foreign-exchange market as well.

China Cash Shortages Push Up Funding Costs, Pressuring Bonds

Traders are betting that the liquidity will tighten further. China’s one-year interest rate swaps -- a gauge of expectations for interbank tightness -- increased to the highest since late January this week.

China Cash Shortages Push Up Funding Costs, Pressuring Bonds

The cash shortage has taken its toll on government debt. Commercial lenders -- the major buyers of the bonds -- now have less money to purchase the securities. Banks may even need to sell their holdings in exchange for funding. Risk-on sentiment sparked by headlines that the U.S. and China saw progress in their phase-one trade deal only worsened the bond retreat this week.

China Cash Shortages Push Up Funding Costs, Pressuring Bonds

Concerns on tight liquidity have not been eased by recent PBOC funding. The amount of net cash injections by the central bank into the financial system so far this month has totaled 830 billion yuan ($121 billion). The authorities will add more liquidity through open-market operations in the near term, said Wang Yifeng, Beijing-based chief banking analyst at Everbright Securities Co.

©2020 Bloomberg L.P.

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