IFR Comment: PBOC - Markets throw in the towel, things getting serious
It was another day of records for China’s money markets overnight with the one-day and seven-day repo rates up into double digits and trading as high as 25% and 20% respectively. As a result of the moves we now have an inversion in the one to five-year spread on swaps at its widest level even going beyond the 2011 wides.
The moves in the money market rates come after the PBOC’s refusal to inject liquidity choosing to instead take a longer term attitude toward reforms and punishing irresponsible banks.
The moves in themselves suggest that the time for action has arrived as the cost/benefit analyses of punishing banks, compared to risks to the economy/financial system, seem to have now titled towards providing some relief. A one-day repo rate that is as high as 25% and a seven-day repo rate as high as 20% show that the market is not functioning and thus a reason to act.
The market has thrown in the towel when it comes to expecting the PBOC to provide assistance. With the record money market rates and higher volatility the PBOC has managed to inject risk into a system that had thought the central bank would inject liquidity whenever it was required. This element of the risk equation is important in the reform process, as is regaining control of the credit creation process and clamping down on shadow banking.
As long as the PBOC is comfortable that they are simply punishing banks and the risks to the economy and financial system can be controlled they could choose to stand by and allow the tightness in money markets to continue.
But what is happening in China has now become a lot more important for risk markets despite something of a pre-occupation with the Fed tapering QE.