China Bonds Drop as PBOC Demand Gauging Fuels Talk of Debt Curbs

(Bloomberg) -- China’s bonds fell as the central bank gauged demand for a 14-day lending tool for the first time since February, fueling speculation policy makers will tighten the availability of cheaper seven-day funds as they seek to limit the use of short-term borrowing to finance debt purchases.

The cost of 14-day reverse-repurchase agreements in the interbank market is 2.70 percent, which compares with 2.40 percent on seven-day contracts and 2.04 percent for overnight funds, according to weighted average prices from the National Interbank Funding Center. The yield on 10-year sovereign bonds increased by five basis points to 2.74 percent on Tuesday, making it less profitable to finance purchases of the securities using 14-day money.

“The cost to obtain 14-day funds from the People’s Bank of China would be higher than the overnight or seven-day rate, so the banks which get the money won’t lend it to peers in overnight or seven-day contracts,” said Yan Yan, a Shanghai-based trader at China Guangfa Bank Co. “The bond market bull run might have added further incentive for traders to borrow short-term funds, leading to higher financing demand.”

Swaps Surge

The cost of one-year interest-rate swaps, the fixed payment to receive the floating seven-day repo rate, climbed seven basis points, the most since July last year, to 2.51 percent, data compiled by Bloomberg show. The benchmark seven-day repo rate added six basis points to 2.40 percent, the highest since July 27, weighted average prices from the National Interbank Funding Center show.

The PBOC’s move to add 14-day reverse repo agreements into demand gauging damps expectation for a near-term cut in interest rates or bank reserve ratios, according to Frances Cheung, head of rates strategy for Asia ex-Japan at Societe Generale SA.

China’s government bonds are heading for their third monthly advance in a row, with the benchmark 10-year yield falling to the lowest level in at least a decade on Aug. 15. Transactions of overnight repurchase agreements climbed to a record 50.4 trillion yuan ($7.6 trillion) in July. That compares with an average of 31.8 trillion yuan last year, data compiled by Bloomberg show.

With assistance from Helen Sun