CGB yields should stay anchored. August monetary data pointed to persistent weakness in domestic credit demand. M1 growth only edged up from 4.0% YoY in July to 4.1% in August. This was still much lower than the 7.5% advancement of M2, as depositors were unwilling to hold liquid cash for consumption and investment. New aggregate social financing fell to RMB1.7tn in August from RMB2.6tn a year earlier. Both short and mid-long term household loans contracted amid continued sour consumption, property market transactions, and early mortgage repayments. Corporate borrowing also fell alongside subdued investment sentiment. Government bond issuance growth decelerated further amid contracting public spending. Due to the asset- and liability-heavy old economy routs, the rise in bond and equity issuance from the technology sector could not translate into a material recovery in overall credit demand.
The data reinforces the case for policy support, with the PBOC likely to rely more on liquidity injections. This could include larger open-market operations and targeted liquidity facilities to ensure adequate funding for banks. The authorities are also planning to recapitalize eight major banks and insurers. The RMB300bn injection should strengthen bank capital and support credit supply. As weak credit demand limits the transmission to the real economy, banks are incentivized to allocate excess liquidity to bonds.
Meanwhile, we see limited room for the PBOC to deliver another policy rate cut in the near term. First, falling bank net interest margins (NIMs) remain a key constraint. Combined with tepid loan demand, low lending rates are putting further pressure on banks’ profitability. At the same time, the low-yield environment is increasingly challenging for insurers. Declining bond yields are weighing on investment returns, which in turn could put pressure on policyholder payouts. Second, the PBOC could stay on pause amid uncertainty over the monetary policy trajectory of major central banks, including the Fed, ECB and BOJ.
The upshot is that CGB yields should remain under downward pressure, but further downside should be limited by an extended PBOC pause. Curve-wise, we continue to see steepening, as liquidity injections are likely to have a more pronounced impact on short-end rates.
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