Weeks after China's central bank chief mapped out a new monetary-policy framework, authorities have taken steps to tweak liquidity operations, introducing tools economists say are more in line with how the Federal Reserve operates.
The aim: to bolster the Chinese central bank's arsenal, giving it more firepower to guide market rates and defend the yuan. While the moves bring the People's Bank of China closer to its western peers' practices, economists aren't sure it's enough to steer bond yields in the long term, noting that attempts by other central banks have shown mixed results.
Part of the PBOC's overhaul is the launch of an overnight cash-management mechanism to better influence short-term borrowing costs. The bank has also teed up agreements to borrow billions in government bonds, signaling the restart of treasury trading, a tool it's rarely deployed over the past decade but which is widely used by advanced economies to manage liquidity and guide longer-term yields.
"The PBOC is tightening its grip on both ends of the yield curve," Barclays economists said in a recent note.
The bank is trying to rein in China's overheated bond market, where yields have been pushed to record lows as concerns about the economy fuel demand for safe-haven assets. Authorities have warned against the frenzy, flagging risks of financial instability and fearing more pressures on the yuan amid an already-wide yield gap with the U.S.
Analysts see promise in one aspect of the reform: the narrowing of the so-called interest rate corridor--a band within which short-term borrowing costs can fluctuate between a set floor and ceiling.
Barclays economists say the corridor is "notoriously inefficient," complicated by a multitude of policy rates that hinder policy transmission.
Unlike the Fed which mainly targets the cost of short-term interbank loans to guide rates, the PBOC has several policy rates in play. But one of the PBOC's recent moves introducing discretionary repo and reverse repo operations in the afternoon--simplifies this. The overnight repo rate is set at 20 basis points below the seven-day reverse repo rate while the overnight reverse repo rate is set at 50 basis points above the seven-day reverse repo. Economists say this will consolidate the seven-day reverse repo rate's role as the new policy benchmark and effectively narrow the corridor.
The corridor has been too wide to be meaningful, Nomura economists said in a note. A narrowed corridor means more predictable short-term rates, which discourages the borrowing of cheap money to invest in long-term bonds, analysts say.
"The new set-up reduces the likelihood of a short-term liquidity crunch in the case of large bond sales," Barclays said.
This smooths the way for the PBOC to sell bonds without worrying as much about the side effects, economists at Pantheon Macroeconomics said in a recent note.
The overarching aim seems to be to set a floor under long-term yields by selling bonds while also providing front-end liquidity to steepen the bond yield curve, economists at Goldman Sachs said.
The moves are somewhat reminiscent of the Fed's "operation twist" in 2011-2012, when it sold short-dated maturities to fund purchases of longer-dated bonds in a bid to lower longer-term rates and boost the economy, but in reverse.
Even if a more Fed-like PBOC manages to steer markets in the direction it wants, there are elements outside its control, analysts say. While bond operations could stop yields' freefall in the short run, factors like China's economic recovery and the timing of Fed easing are also in play.
China's latest economic data, which showed weaker-than-expected second-quarter growth and still-soft inflation, suggest little in the way of support for long-term yields.
"Longer-term macro fundamentals need to improve significantly to sustain any move upwards in yields," Barclays said.
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(END) Dow Jones Newswires
07-16-24 0135ET
