China’s efforts to inject liquidity into its financial system have failed to relieve the ongoing pressure in the money market, with borrowing costs remaining elevated despite the People’s Bank of China’s (PBOC) recent efforts.
On Friday, the PBOC added a net 84 billion yuan ($11.6 billion) through its daily open market operations, marking the largest infusion in February. However, money market rates remained stubbornly high, underscoring the tight liquidity conditions. The seven-day repo rate climbed 14 basis points to 2.2%, while the overnight repo rate stayed near an eight-month high. These persistent pressures were reflected in a slight increase in government bond yields across various tenors.
The central bank’s cautious stance on liquidity has been aimed at supporting the yuan, which has faced headwinds from both domestic economic challenges and external pressures, including trade tensions with the US. However, the tight liquidity is causing strain in China’s bond market, as evidenced by the 10-year government bond yield reaching its highest point since December. This has been compounded by shifting investor sentiment, with money flowing into stocks amidst a tech-driven rally, further contributing to the selloff in the bond market.
Lynn Song, Chief Greater China Economist at ING Bank, noted that the PBOC’s shift to net injections of liquidity was a response to the growing tightness in interbank rates. However, Song added that the impact of the seven-day reverse repos on the broader market would be limited.
While the central bank’s actions are seen as a necessary step to stabilise the economy, the move has not alleviated the overall tightness in onshore liquidity. Traders reported that overnight funding rates for certain financial institutions spiked to 2.5%, indicating persistent stress in the short-term funding market.
The reversal of sentiment in the Chinese debt market is stark. A strong initial demand that previously pushed yields to record lows has now given way to a selloff. This shift in market sentiment has dampened expectations of further easing by the PBOC, as the central bank’s focus has shifted toward stabilising the yuan rather than offering additional stimulus.
The central bank faces a delicate balancing act. While it aims to stabilise the yuan and control inflation, it must also address the concerns of businesses that rely on affordable borrowing costs to fuel growth. As the Chinese economy shows signs of weakness, market participants are keenly watching for any signs that the PBOC will shift its approach and introduce looser monetary policies.
The PBOC recently signalled that it would remain flexible with its policies, adjusting the pace and intensity of measures depending on both domestic and international economic conditions. However, it remains uncertain how long the current liquidity squeeze can persist without further exacerbating the economic challenges facing China.
