China IRS up, tightening cycle seen still in place

Most Chinese interest rate swaps rose on Friday, indicating the market remained jittery over more tightening measures in the near term to soak up
relatively ample liquidity in the banking system.

The central bank is widely expected to stay on course with its tightening campaign to keep up its battle against inflation, although the headline consumer price levelled off in February.

"The liquidity is still ample in the money market. If such a condition continues, of course the central bank will do something to change it," said a trader in a state bank in Shanghai.

Instead of an imminent rise in reserve requirements or interest rates, traders said the central bank may continue to rely more on open market operation tools in the coming weeks.

"The central bank will probably auction more bills next week, as the issuance amount of three-month bills yesterday is not big," said a trader at a state bank in Shanghai.

The benchmark five-year IRS CNYQB7R5Y= rose 3 basis points to 4.0600 percent at midday from 4.0300 percent at Thursday's close.

The one-year IRS CNYQB7R1Y= rose 1 basis point to 3.4300 percent while the longest 10-year IRS CNYQB7R10Y= dropped to 4.2200 percent from the previous close of 4.3000 percent.

"You can see the market is still awash with cash, although the central bank drained a net 10 billion yuan from the market this week," Shi Lei, an analyst at Ping An Securities in Beijing said.

Indeed, in the money market, the weighted average seven-day repo rate CN7DRP=CFXS, the main barometer of short-term liquidity supply, dropped 22 basis points to 2.0526 percent from 2.2751 percent at Thursday's close.

SLUGGISH SENTIMENT

China's government bond yields moved up on Friday as a set of robust economic indicators in February tempered earlier market concerns about slowing economic growth.

By midday, the yield on the benchmark five-year government bond CN5YT=RR climbed 12 basis points to 3.60 percent while the yield on the 10-year benchmark bond CN10YT=RR added 3 basis points to 3.94 percent.

"Bond market investors are starting to take a cautious attitude and the enthusiasm for buying long-term products are cooling down a bit," said Shi Lei at Ping An securities.

Traders said the strong economic activity figures in February could give the central bank more leeway to raise interest rates in the coming months if necessary.

China's industrial output in the first two months rose 14.1 percent from a year earlier from a 13.5 percent pace in December and fixed asset investment also beat the market forecast, reaching 24.9 percent during the same period.

"All the previous expectations of a slowing economy have been changed, so the upward trend of bond yields will continue for some time," said a trader at a state bank in Beijing.                      

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