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China’s Markets Already Pricing In More Central Bank Easing

A motorcyclist rides past the People's Bank of China building in Beijing. Photographer: Qilai Shen/Bloomberg

Economists are virtually certain China’s central bank won’t follow others in unleashing large-scale monetary stimulus any time soon. Investors are betting on it anyway.

Those expectations helped kickstart a fresh rally in the country’s government bonds on Tuesday as markets reopened after a long weekend. Futures surged the most in two months and the benchmark 10-year yield fell to the lowest since 2002. The CSI 300 Index of stocks rallied 2.3% to a more than three-week high, while a gauge of liquidity-sensitive small caps had its best day since mid-February. The yuan strengthened the most in nearly two weeks.

While economists are unanimous in ruling out policies like quantitative easing, even the slightest surprise in support measures has prompted shifts in sentiment. The People’s Bank of China on Friday unexpectedly cut the interest rate it pays on banks’ excess reserves and reduced the amount of cash that selected lenders need to hold. That added to speculation that there’s more to come.

“Investors are pricing in a slew of policy easing measures, from a cut to the reverse repurchase rate to the benchmark deposit rate,” said Xing Zhaopeng, a market economist at Australia and New Zealand Banking Group, adding the cost on 10-year notes will hit 2.2% in the second quarter. “Government yields will hit new lows across the curve.”

China's 10-year sovereign yield hits lowest since 2002 on easing bets

The PBOC will probably lower rates on medium- and short-term loans to banks, said Ming Ming, head of fixed-income research at Citic Securities Co. That should give lenders more room to cut the loan prime rate, which underpins the cost of borrowing for corporates and households. Beijing could reduce rates on its standing lending facility, China’s version of the Federal Reserve’s discount window, said ANZ’s Xing. Investors are also waiting for the PBOC’s first cut to the deposit rate since 2015.

Other market indicators showing speculation on Tuesday for further easing:

  • Futures on 10-year government bonds surged as much as 1.2% to the highest level on record
  • Futures on 2-year government bonds hit their daily limit by rallying as much as 0.5%
  • The seven-day repo rate slid 28 basis points to 1.3%, the lowest in two weeks
  • The cost on 12-month interest-rate swaps plunged to as low as 1.41%, a level unseen since June 2009, reflecting wagers that the PBOC will keep borrowing costs cheap

It’s all helping revive appetite for Chinese assets. China’s more reticent approach to stimulus had until now underwhelmed investors, who remain hooked on the prospect of further supportive measures. The country’s financial markets had started to lag global peers, after initially outperforming on optimism officials would take bolder steps.

Foreign investors had also cooled on yuan assets, adding bonds at a slower pace in March. After selling onshore stocks on Friday, overseas-based traders bought a net $1.8 billion of the shares on Tuesday, the most since Feb. 3.

Read more on markets and stimulus
China’s Evolving Toolkit to Manage Monetary Policy: QuickTake
Markets Get Reality Check With China’s Cautious Stimulus Steps
Everything China Is Doing to Support Its Markets During Pandemic
PBOC Signals It Won’t Cut Deposit Rate Soon But Will Evaluate

Chinese policy makers have signaled more stimulus is coming, including a higher fiscal deficit and the sale of off-balance-sheet debt for central and local governments. The nation will increase support to small and micro companies hurt by the virus outbreak through tax credits and loans, the PBOC-run Financial News reported Wednesday, citing regulators.

But recent history suggests Beijing will stay prudent rather than risk stoking consumer prices or inflating the debt market. Last month, China cut the reverse repo rate by just 20 basis points. While that was the largest reduction since 2015, it was less than half of Fed’s emergency rate cut a few weeks earlier.

The PBOC said it needs to make a more complete evaluation before touching the deposit rate, suggesting an adjustment may not come so soon. The LPR won’t be lowered by more than 10 basis points in April, according to Citigroup Inc.

“The reduction of the rate on excess reserves will help China guide borrowing costs lower,” said Citic’s Ming. “Policy easing will be the market’s main story line in the near term,” adding the 10-year sovereign yield could drop to as low as 2.4%.

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