China's bond yields mostly fell on Monday, continuing a two-month slide, but traders said the downtrend was slowing due to uncertainty over whether monetary policy would ease as aggressively as previously expected. Bill yields also fell because of ample liquidity and expectations that the central bank may rely on short-term bond repurchase agreements to drain funds rather than weekly bill sales.
Traders believe shorter-term bond yields may continue to fall in coming months because of easing inflation and slowing economic growth, but the decline will become more gradual.
Long-term bond yields, which have already factored in four or five future interest rate cuts, are likely to move sideways because of expectations that the government's use of fiscal as well as monetary measures to bolster the economy may increase the supply of long-term government bonds in 2009. The indicative five-year government bond yield edged down to an 18-month low of 2.9918 percent bid on Monday from 2.9945 percent on Friday, according to Reuters Reference Rates.
But the 15-year yield rose to 3.5482 percent from 3.5245 percent. Onshore interest rate swaps mostly rose, with the 10-year IRS rising to a two-week high of 2.87 percent bid on Monday from 2.50 percent. "Banks bought shorter-term because they are optimistic that monetary policy will keep easing to support economic growth, which is slowing," said a trader at a mid-sized bank in Guangzhou.
INFLATION REMARKS: Central bank governor Zhou Xiaochuan said on state television on Sunday that China must prepare for the challenges sure to be brought about by the global financial crisis, although the economy was generally in good shape.
He cautioned that inflation may rebound, but did not specify how that would affect monetary policy. His relatively hawkish remarks on inflation were in stark contrast to the markets' view that its downward trend will continue for the rest of this year and into 2009.
Some analysts said the comments may indicate that monetary policy easing will be less aggressive as the credit crisis eases. "Officials appear to be split on how optimistic they should be with economic growth and how concerned they should be if PPI and high downstream prices would feed into consumer price inflation," said an analyst at a state-owned Chinese bank.
"Easing of monetary policy may slow considerably if the global financial turmoil fades." In the money market, banks bought bills aggressively because of ample liquidity and expectations that the central bank may gradually cut the supply of one-year bill issues in its regular open market operations.
Traders said the central bank on Monday had asked the extent of market demand for one-year bond repurchase agreements. It has been extremely rare for the central bank to conduct operations with repos with that maturity in recent years.
The central bank may want to use such repos in its open market operations on Tuesday as a partial alternative to its weekly sales of one-year bills, to avoid having to conduct large sales of one-year bills as a means of preventing the auction yield from falling too rapidly, traders said. The one-year central bank bill yield fell to a 15-month low of 3.2690 percent from 3.3610 percent. That decline continued to normalise its spread with the three-year bill yield, which widened to positive 4.8 bps on Monday from 0.6 bps on Friday and negative 14.5 bps on Monday last week.