China: A long phase of deleveraging has just begun – Standard Chartered

According to analysts at Standard Chartered, financial-market stability and deleveraging are taking centre stage in China’s policy making and they do not expect regulatory tightening to ease in the foreseeable future, but the pace of further tightening may be adjusted to avoid a material market disruption.

Key Quotes

“The People’s Bank of China (PBoC) will likely monitor interbank liquidity conditions more carefully near-term; however, the cost of funding of central bank liquidity injections may rise further. We expect the PBoC to hike key money market rates again in June following a potential Fed rate hike, to support FX markets.”

“Interbank liquidity conditions will likely be challenging in June on the quarter-end effect, the macro-prudential assessment (MPA) and self-check deadlines set by the banking regulator. The excess reserve ratio, which was 1.3% at end-Q1-2017, also indicates tight liquidity ahead. The ratio is at its lowest since Q2-2011 and much below 2.1% recorded during the mid-2013 liquidity crunch.”

“We expect the average 7-day repo fixing to rise to 3.8-3.9% in June from 3.5% so far in May and 3.3% in April. We see the 10Y CGB yield peaking at 3.8-3.9% in the coming months before declining to 3.4-3.5% in H2-2017. The bid-to-cover ratio of recent China Government Bond (CGB) primary auctions has slid to a two-year low; we expect primary demand to stay weak and further pressure the secondary market. We recommend paying repo IRS on dips in the near term and preparing for potential bottom-fishing opportunities in cash bonds on a further increase in yields.”