China's bond markets price in policy tightening; analysts disagree

SHANGHAI (Reuters) - A sharp jump in short-term Chinese bond yields in response to a swift dropping of pandemic curbs may be premature, analysts say, pointing to the central bank's policy intent and its attempts to douse speculation of early tightening.

The yield on one-year Chinese government bonds has risen by about 50 basis points since the end of October, which was just before Beijing began dismantling its zero-COVID policy, spurring expectations for rapid economic recovery.

That big move in yield, in a normally stable market whose entire yield curve out to 30 years is between 2.2% and 3.3%, has been excessive, say analysts.

Policymakers need to get consumption levels up, stabilise a struggling property market and lift economic growth before they can consider any monetary tightening, the analysts say.

"Despite an upbeat growth outlook for China this year, we expect China to lower its interest rate further in the coming months," Tommy Xie, head of Greater China research at OCBC Bank.

The reopening has been accompanied by a string of better-than-expected economic data suggesting the world's second-largest economy has bottomed. That has included signs of rebounds in service and hospitality industries and even the struggling property sector.

Loan growth and money market rates have jumped, driving the benchmark volume-weighted average overnight repo rate to 4% last week, its highest in more than two years.

The People's Bank of China (PBOC) has injected funds through its medium-term loan facility (MLF) program. For three months it has pumped in more than the amounts that have been maturing, keeping borrowing costs unchanged. Last week, it made its largest ever single-day cash injection via reverse repurchase agreements.

In December, PBOC Deputy Governor Liu Guoqiang said monetary policy in 2023 would ensure enough cash was in the economy and would be tailored to help key sectors, a point the central bank reiterated last month.

Tommy Wu, senior economist at Commerzbank, expects that the PBOC will cut the MLF rate soon after the annual session of China's parliament, scheduled to begin on March 5, and that banks will subsequently cut lending rates.

"Macro policy stimulus will likely be announced during the annual session," he said, adding that the timing would be good for a PBOC rate cut, which would signal that it stood ready to support the economic recovery.

BETS ON STEEPER CURVE

Because front-end yields have risen while longer-end rates have been steady, the yield curve has flattened. The spread between the 10-year yield and one-year has shrunk by about 30% to 67 basis points over four months.

Analysts recommend steepening trades - receiving short-end rates and paying longer rates - to bet the curve will become steeper as short-end rates re-align with policy.

Citi said it was underweight China in its emerging markets bond portfolio, expecting 10-year bond prices to fall as yields rose to 3.3% in the weeks ahead. Ten-year yields are around 2.92%.

"There is unlikely to be any material easing or tightening," said Frances Cheung, rates strategist at OCBC Bank. Policy would be mostly neutral, she said. If onshore liquidity demand remained high in coming weeks, the PBOC would probably stay supportive.

OCBC saw the curve steepening, with front-end yields better anchored by a supportive monetary policy while the longer end responded more to fiscal stimulus, recovery in economic growth and a rise in inflation.

(Reporting by Li Gu, Winni Zhou and Brenda Goh; Editing by Vidya Ranganathan and Bradley Perrett)