Another month, another spike in Chinese money market rates. Such volatility is becoming the new norm as the PBOC continues to hammer home its message on responsible lending and liquidity management. Averse to providing liquidity broadly through regular open market operations the CB is expanding its use of more targeted injections to maintain the pressure on banks not bowing to the central bank’s wishes.
The PBOC announced that is had extended the role of its Standing Lending Facility (SLF), on top of the short-term lending operations (SLOs) it has opted for lately to make those targeted injections. Small and medium-sized banks will now be able to apply for direct cash injections via the SLF when the seven-day repo rate is over 7%.
This is significant: the PBOC is not taking a complete hands-off approach and looking to limit how tight conditions become, even if the latest jump in money market rates is unlikely to be reversed quickly. SLOs had previously served as a form of secretive support to select large banks, but that role is being supplemented by an expansion of the SLF in what markets an improvement in the PBOC’s transparency on liquidity.
SLOs and SLFs do not differ much: both are discretionary, with the former providing liquidity for 1-3 days while the latter does so for a slightly longer tenor of 1-14 days. The SLF also has thresholds for when liquidity can be applied. Until Chinese New Year, which begins on Jan. 31, this will be 5% on o/n repo rate, 7% on the seven-day repo rate and 8% on the 14-day repo rate. These thresholds are likely to be adjusted in the future depending on how tight the PBOC wants money market conditions to get.
It was only Friday that the PBOC reiterated its message urging lenders to strengthen liquidity management and “reasonably set the pace of lending” to better serve the real economy. This has been the PBOC’s consistent refrain since last June as the central bank looks to promote bank and shadow banking deleveraging in a smooth manner. The thresholds will provide another means to gauge the PBOC’s satisfaction with banks lending practices.
Money market rates have once again spiked higher – as high as 10% with the weighted average jumping 144 bps to 6.5920% – as the PBOC skips its open market operations for two weeks in a row, creating a pre-holiday squeeze. The PBOC has indicated that it has already used the SLF for large banks and will add liquidity via reverse repos on Tuesday. This is unlikely to turnaround tightness in money markets completely but will provide liquidity assurance ahead of January 31.
The PBOC will continue to use tighter conditions as a stick to change lending behaviour, with the carrot of the SLF/SLO available only to those willing to listen. The new environment seems to be one of more frequent spikes in short-term rates to force better liquidity management while using a combination of SLFs/SLOs to maintain money market functioning.
We still think that a stronger lesson on responsibility will be delayed until either March or June to coincide with likely 3-month or 6-month maturity humps on short-term funding.
