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China's bond yields fell on Friday ahead of inflation and other economic data next week while bill yields tumbled due to expectations the central bank will boost money market liquidity in coming months. But onshore interest rate swaps bucked the trend with longer-term IRS rising sharply as funds paid fixed IRS for that part of the curve to hedge risk in the bonds they bought.
Bonds were also sought after on rising expectations that China's October annual consumer price inflation, due next Tuesday, will ease to about 4 percent from 4.6 percent in September, which could give the central bank more room for at least one more interest rate cut this year.
The central bank's decision in the past week to issue three-month and one-year bills via bi-weekly rather than weekly sales in its open market operations, was seen by some traders as a move to phase out bill issuances for fund injections instead. "Traders are buying bonds because of expectations that the central bank will boost liquidity in response to falling inflation and industrial output growth data in October," said an analyst at a major Chinese bank in Beijing.
The indicative five-year government bond yield fell to a 19-month low of 2.7755 percent bid on Friday from 2.8245 percent on Thursday, according to Reuters Reference Rates. But the 10-year IRS, which slipped on Tuesday in response to the central bank's change in open market operations, resumed its rise to a two-week high of 2.70 percent bid on Friday from 2.40 percent on Thursday.
Funds sought to pay fixed in IRS, which are sensitive to short-term bond repurchase rates, on views repos may not fall sharply in the near term because of strong demand for bonds and as big Chinese banks remain wary of taking on counterparty risk.
In the money market, bill yields fell across the curve because of expectations the central bank may cut banks' reserve ratios by 0.5-1.0 percentage point in coming months and make more cuts next year, and even entirely halting bill issues next year.
Traders believe bill yields will continue to face downward pressure and the extent of declines may even pick up towards the end of the year as the "unofficial" floor of the seven-day repo rate hits 2.5 percent at the end of the year.
"The central bank is likely to make small injections in open market operations for the rest of this year but may inject substantially more funds earlier next year because of the large amount of bills maturing at that time," said an analyst at a major Chinese bank in Beijing. The weighted average seven-day repo rate fell to 2.7919 percent by midday, its lowest since July, from 2.8509 percent on Thursday. The 90-day central bank bill yield fell to a 17-month low of 2.7630 percent bid on Friday from 2.8550 percent.

Copyright Reuters, 2008

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