China central bank cash injection signals leverage, asset bubble concerns

By Nathaniel Taplin and Winni Zhou

SHANGHAI (Reuters) - China's central bank injected cash into money markets through 14-day reverse repo agreements for the first time since February in a sign policymakers were worried rising leverage could stoke bubbles in the bond market.

Analysts say the switch to longer tenor, higher interest rate injections may signal the central bank is concerned that too much of short-term borrowing is flowing into the bond market. For most of 2016, the People's Bank of China (PBOC) has effectively targeted the lower interest seven-day rate, with cash injections nearly every day.

The PBOC on Wednesday injected 90 billion yuan ($13.55 billion) into money markets through seven-day reverse bond repurchase agreements (repos) and an additional 50 billion yuan through 14-day reverse repos on Wednesday, traders said.

"The PBOC appears to be signalling to banks to move away from a reliance on short-term liquidity and head towards more longer term liquidity," wrote Jonas Short, Head of NSBO Policy Research in Beijing in a Wednesday note.

The major worry for policymakers, some analysts say, is that rising repo leverage and the over-reliance of smaller banks on short-term liquidity threatened asset price bubbles in the debt market, and added to systemic banking sector risks.

"The market read this (the 14-day queries yesterday) as the signal that PBOC may want to curb leverage in bond market as funding cost from 14-day reverse repo is higher than from 7-day and overnight reverse repo, which may increase costs for leverage," wrote analysts from OCBC Bank in Singapore Wednesday.

"The recent rally in bonds fuelled by leverage on the back of stable short-end funding raise concerns about potential asset bubble risks in China's bond market."

Indeed, Chinese debt has sold off over the past week as doubts on further broad-based monetary easing have risen and investors took profits following a sharp rally in onshore bonds, which pushed the ten-year Chinese treasury to seven-year lows in mid August.

The market reaction was swift, with the volume weighted seven-day rate, considered the best general indicator of liquidity in China trading at 2.50 percent by mid afternoon Wednesday, up ten basis points (bps) from Tuesday's closing average rate.

Analysts suggested small banks could bear the brunt if short-term liquidity remains tight.

"Overall, small banks are likely to continue to struggle should short-term interbank rates continue rising as the double whammy of a high interbank borrowing rate coupled with tightening on issuing financial products suggests there may be potential for a liquidity squeeze for small banks on the horizon," said NSBO Policy Research's Short.

In fact after the news broke on Tuesday that the central bank was querying banks on demand for two-week reverse repurchase agreements (repos), the benchmark seven-day repo rate notched its highest close since January at 3.24 percent.

"Cash is extraordinarily tight today, you're seeing the seven-day hanging around 2.8 percent, you can't get 14-days and people are being pushed into the 21-day," said a trader at a Chinese bank.

With the central bank's move to 14-day reverse repos for the first time since February, some in the market took it as a signal that further cuts to bank required reserve ratios were unlikely.

Chinese treasury futures promptly sold off on the news, with the price of the ten-year future for December delivery falling 0.38 percent, the biggest move downward in over three months.

In bond market trading on Wednesday morning, Chinese five and ten year treasury futures were both down 0.1 percent. The yuan was down 0.2 percent against the dollar while the benchmark CSI300 equities index was down 0.1 percent.

Some analysts said that only a sustained move higher in the seven-day or one-day repo rates would indicate the central bank was trying to curb leverage in the repo market.

"Unless we see a significant one-up move in the seven-day repo, I think we can conclude that the policy stance is unchanged for now," said Julian Evans-Pritchard, China Economist at Capital Economics in Singapore.

"It would be odd that they would raise the repo rate at the moment given the current worries on the economy and investment."

(Reporting by Nathaniel Taplin, Winni Zhou and the Shanghai Newsroom; Editing by Kim Coghill & Shri Navaratnam)