China engineered a pretty epic cash squeeze this week.
Liquidity withdrawals over the past several days stoked fears of tighter policy at a time when the market was already concerned that relative strength in the world’s second-largest economy was emboldening the PBoC, which has made no secret of its desire to dial down accommodation, exercise “prudence,” and otherwise normalize policy now that the pandemic has subsided.
The central bank’s efforts to drain liquidity drove up interbank rates, and while this might sound like a tedious discussion for market participants accustomed to the kind of fireworks seen in the US this week, it’s notable.
From Tuesday through Thursday, for instance, China drained some 328 billion yuan from the interbank market. It probably felt, to some anyway, like an almost spiteful effort to squeeze folks who were opportunistically capitalizing on cheap funding.
This is the furthest thing from complicated. “Cheap short-term financing enabled bond traders to make a killing buying sovereign debt with borrowed cash,” Bloomberg wrote, noting that this carry trade “was so popular earlier in January that daily turnover in overnight repos touched a seven-month high.”
“In late December and early January, repo rates fell to the lowest levels since mid-2020 and leverage in the interbank market built commensurately,” Goldman said, adding that “the recent liquidity drain may be part of the PBoC’s efforts to reduce financial leverage.”
As you can imagine, China’s efforts have been “successful,” depending on your definition of “success.”
While it’s certainly true that Beijing has lost control at times (e.g., the infamous 2015 stock mania, the long-running LGFV problem, and what many insist is a rolling property bubble), short-term crackdowns are generally effective. This was no exception. For example, the carry trade referenced above was stamped out (figure below).
Jitters ahead of the Lunar New Year holiday are palpable. “Unlike previous cash crunch[es], it’s really hard to tell when the conditions will start to loosen up this time,” one trader told Reuters, which noted that “investors are getting increasingly worried.”
Goldman expects a push-pull dynamic for the next couple of weeks, with the PBoC attempting to balance various concerns.
“In the very near term, we think the combination of seasonal liquidity demand, the focus on controlling financial leverage, and the healthy growth momentum may translate into continued tightness and elevated repo rates in the interbank market,” the bank said, adding that they expect the PBoC to “meet the seasonal swings in liquidity demand, like it did in previous years, to avoid extreme increases and volatility in front-end rates.”
Still, things could remain “on the tighter side in the short run,” Goldman remarked, in the same note.
And that’s what has some folks concerned. Chinese stocks sold off the most since July this week.
“Chinese equities will remain under near-term pressure as long as 1-year swap rates stay elevated, if history is any guide,” Bloomberg’s Mark Cranfield wrote Friday, adding that while China “may be a long way from an official interest rate hike, as long as money market rates are allowed to stay high, the message to equities is clear enough.”
Clear enough, indeed.
Still, Beijing is adept when it comes to keeping the proverbial plates spinning — juggling acts are a point of pride. In that regard, AxiCorp’s Stephen Innes said Friday that “with state media sending soothing signals saying liquidity injections via multiple monetary tools may increase ahead of [the holiday], I expect the central bank to keep liquidity reasonably ample.”