Jitters in the Chinese interbank space; INR bonds bask in glow

Credit jitters hit China rates; India govvies basking in post-election glow.
Eugene Leow, Radhika Rao28 May 2019
    Photo credit: AFP Photo

    China Rates: Jitters in the Chinese interbank space
    The Baoshang Bank takeover (by the authorities) led to jitters across China’s interest rates space, some of which may not be warranted. To be sure, the bank’s assets are small relative to the banking system. However, market participants are rightly worried that other small banks may be subjected to the same takeover risks. Moreover, there has only been guarantees on retail and corporate deposits (of under CNY 50mn), leading to uncertainties on the bank’s other liabilities. Accordingly, there were contagion fears, driving 1Y swaps (vs 7D repo) up by 7bps yesterday. The 1Y swap (vs 3M Shibor), which measures banking system risks more succinctly, popped by an even larger 11bps. At this point, the equity market is unfazed, with only the rates and credit space showing some signs of stress.

    While it can be argued that credit risk is elevated compared to last week, we reckon that the authorities would inject ample liquidity to cap any overreaction in the rates space. With economic indicators mixed and trade war risks lingering, the bias is still tilted towards loose monetary policy to cushion growth. We think that the rise in longer-term govvie (and Development Banks) yields is probably not warranted. Notably, 10Y govvie yields are now close to the top of its recent 3.10-3.40% trading range. In the event of risk aversion, we would reasonably expect government bonds to hold up.
    India rates: Bonds bask in stable politics and liquidity glow

    INR sovereign bond markets have gained on the back of domestic catalysts, leading to a pullback in the yield curve. 10Y yields (generic) slipped from 7.3% to 7.17% in the past week, whilst 2Y rates eased ~10bp to sub-6.5% on policy easing expectations. Final election results led to a decisive win for the ruling coalition (and lead party), better than exit polls suggested and the 2014 count. Staying on for a second term with an emphatic majority underscores policy continuity and stable political environment for the next five years. 

    The RBI announced a tranche of INR150bn worth bond buybacks via open market operations for June 6, after INR250bn in May. While this was a more measured quantum than anticipated, markets expect this to be first of many. April-May are seasonal favourable months for domestic liquidity, but the situation this year was aggravated by ongoing elections, which has led to higher government cash balances with the RBI, due to a delay in fiscal spending and higher cash in circulation. We expect this to partly ease over the coming weeks.

    Concurrently, the special window for foreign portfolio investors i.e. Voluntary Retention Scheme (VRR) was tweaked, as limits for government debt and corporate bonds were merged. To recall, when the previous VRR window closed in April, interest in GSecs was weak, while corporate limits were partially taken up. With the mainstream limit for FPIs still to be fully utilised (66% used up as of yesterday), global risk sentiments also need to be conducive for inflows to return.

    Bonds are likely to enjoy a reprieve after a tough start to FY20. With 1Q19 GDP data on Friday likely to see growth slow to 6.1% YoY from 6.6% quarter before, and inflation at still sub-3% in April vs target at 4%, expectation for a 25bp rate cut in June is rising again. Oil prices are off highs and a recent breather from US dollar strength has lowered depreciation pressure on the currency.

    10Y yields are likely to consolidate around 7.2% heading into the rate review, as markets pin for more liquidity support, scope for which is limited in our view. 2Y yields are likely to ease towards the 6.5%, narrowing the gap vs repo rates.

    In the INR credit space, the RBI rolled out a draft liquidity framework for non-banks, which will likely be finalised by mid-June. Proposals include plans to impose the Liquidity Coverage Ratio (LCR) on non-banks in a phased manner, a revision of asset-liquidity norms, active liquidity risk monitoring system, streamlining treatment of funds, amongst others. While these might hurt the profitability and raise costs for few non-banks, authorities are keen to ring-fence the sector and prevent a systemic squeeze.

    Eugene Leow

    Rates Strategist - G3 & Asia

    Radhika Rao

    Economist – India, Thailand & Eurozone

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