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Chinese Premier Li Keqiang held a State Council meeting on 11 March. Two key signals were released there:

  • Speed up credit supply to industries and enterprises.
  • Implement targeted cuts in reserve requirement ratios (RRRs).

 

The signals are very clear, so we will see further liquidity loosening in mainland China in the near term. We expect a targeted RRR cut will be announced very soon. Needless to say, further reduction of loan prime rates (LPRs) will also happen at the regular fixing on 20 March.

In regard to the China government bond (CGB) trading strategy under the prevailing environment, we here reiterate our bullish view.

Recall, we said in the previous issue of this publication "with the market pricing more monetary easing in China and further spread of the COVID-19 globally, CGB yields should see more downside potential from here. We expect 10-yr yield, at 2.66% (when the article was written on 6 March), will reach as low as 2.50% by the end of H1".

Much sooner than we expected, the yield hit as low as 2.51% on 9 March. Though upward retracement happened afterwards, the upside was limited to 2.65%. Given the fact that RRR cut looks imminent, we expect CGB 10-year yield (currently at 2.64%) will make another downside attempt on 2.50% shortly and then see an extension of the downward move for 2.30% (chart 1).

China Insight    

 

Another reason why we remain bullish on CGBs is the market currently is not crowded with long positions at all. Chart 2 shows a lot of market participants were reducing their holdings of CGBs over the past two months. The reduction may be attributed partly to market participants' concerns over an acceleration of inflation pressure as a result of the COVID-19 outbreak and partly to their unawareness of a potential Fed funds rate cut by as much as 50bp on 3 March.

With the COVID-19 outbreak expanding rapidly and US equities continuing to slump, another 50bp cut at 17-18 FOMC meeting seems to be a done deal. While the global economy is on the edge of recession, central banks, led by the Fed, will be opting for continuous monetary easing. Against this backdrop, those who wrongly reduced their CGB holdings in Feb have no choice but to buy back the papers.

China Insight          

 

Last but not least, chart 3 shows from now on there will be sizable maturities of OMO liquidity injections each month (except May) till September. In our view, PBOC, in order to avoid the concerns over a potential liquidity tightening from heating up, will be biased towards keeping the banking system liquidity more ample than necessary when the country is still fighting with COVID-19. That of course is also a positive to long positions in CGBs.
 China Insight 

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