China’s money markets are set to experience a significant liquidity withdrawal of over 3 trillion yuan ($411 billion) this month, potentially keeping funding costs high before critical legislative meetings in March.
The majority of this liquidity drain will stem from the 2.4 trillion yuan required to settle maturities of so-called policy loans from the central bank. An additional 820 billion yuan is expected to be absorbed by bond issuance from local governments, according to estimates from Huachuang Securities and data compiled by Bloomberg.
Tight Liquidity to Support the Yuan
The tightening of liquidity is seen as a strategic move by Chinese authorities to help support the yuan amid ongoing uncertainties over US tariffs. Since the end of the Lunar New Year holidays on February 5, the People’s Bank of China (PBOC) has already withdrawn approximately 1.5 trillion yuan from the money market through its daily open-market operations.
“Maintaining tight interbank liquidity is indeed helpful for defending the onshore yuan in such a volatile environment,” said Becky Liu, Head of China Macro Strategy at Standard Chartered Bank in Hong Kong. “China will likely keep the situation stable for now,” especially with potential tariff negotiations between US President Donald Trump and Chinese President Xi Jinping.
Liquidity Tensions in the Interbank Market
This tight liquidity is evident in the interbank market, where the spread between the overnight repo rate and the policy repo rate widened to 41 basis points this week, close to the widest level seen in four years.
Two Sessions and Economic Stimulus
China’s annual “Two Sessions” — the National People’s Congress and the Chinese People’s Political Consultative Conference — will convene in March. These key meetings are expected to feature announcements of new fiscal stimulus measures aimed at bolstering the country’s struggling economy. Some analysts also anticipate further monetary easing.
However, Lynn Song, Chief Economist for Greater China at ING Bank in Hong Kong, suggests that any cuts to the reserve requirement ratio (RRR) for banks might be postponed until after the Two Sessions. “Releasing new monetary easing measures after the Two Sessions would send a positive signal to the markets,” she said.
Maturing Policy Loans and Market Impact
Among the maturing policy loans this month are collateral reverse repurchase agreements, medium-term lending facilities (MLFs), and outright reverse repos. The pressure from these maturing loans contributes to the overall liquidity crunch.
Effects of Tighter Conditions
One notable impact of tighter liquidity is the reduced appeal of a popular trade: borrowing money to purchase sovereign bonds. The yield on 30-year debt fell 10 basis points below the overnight interbank rate this week, marking the largest discount since December 2013.
Some analysts believe that the PBOC may still opt to inject additional liquidity into the market if cash demand leads to stress. In January, the central bank injected a record amount of funds via three- and six-month outright reverse repo agreements.
Potential Monetary Easing Amid Deflation Threats
Despite the current uncertainties surrounding potential trade negotiations between China and the US, the ongoing threat of deflation in China’s economy means that the central bank may still need to lower its reserve requirement ratio (RRR) and reduce open-market operations rates this quarter.
“China fundamentally needs more monetary policy easing, and the negotiations may only delay this by a matter of weeks,” said Standard Chartered’s Liu.
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