China sees fierce pre-holiday liquidity scramble, short rate surges but yuan dips
SHANGHAI (Reuters) - Short-term funding costs in China shot to their highest in nearly 10 years on Thursday on fears that liquidity was sharply tightening heading into the long Lunar New Year holidays.
The sudden surge in funding rates ahead of one of the heaviest cash demand periods of the year has forced traders with short positions against the yuan to bail out of their positions.
That has led to a solid strengthening in the beleaguered currency this week, though it dipped on Thursday on signs that state banks may be offering some additional yuan supplies and after an overnight bounce in the U.S. dollar.
Spot yuan was trading at 6.8556 to the dollar by midday, 124 pips weaker than the previous close and only 0.02 percent stronger than the midpoint guided by the central bank.
But it is up more than half a percent so far this week, on course for its best week since July. It has firmed around 1.2 percent so far this year as Chinese authorities try to cool market expectations of further declines.
"The market has calmed down slightly. (But) we have U.S. President-elect Donald Trump's inauguration in two days and that may create volatility again," said a trader at a Chinese bank in Shanghai.
Households and companies usually withdraw large amounts of cash from banks ahead of the week-long New Year holiday, which starts on Jan. 27. This year, the holiday also extends over the month-end, when corporate cash demand increases and some tax payments are due, adding to heavy demand.
While liquidity always tightens in China ahead of the holiday, and the People's Bank of China (PBOC) routinely steps up its money injections ahead of the break, traders were spooked when the central bank unexpectedly decided not to rollover maturing medium-term lending facility (MLF) loans on Wednesday.
Further MLF loans are due to mature on Thursday.
The onshore overnight implied deposit rate for yuan touched a high of 22.099 percent in early trade on Thursday, compared with the previous close of 22.035 percent.
Levels are now the highest since data became available in April 2007. On Tuesday, the rate ended at 4.357 percent.
The volume-weighted average rate of the benchmark seven-day repo traded in the interbank market, considered the best indicator of general liquidity in China, was 2.5115 percent at midday, compared with the previous close of 2.7607 percent which was the highest since July 2015.
The official midpoint was fixed at 6.8568 per dollar prior to the market open, 43 pips weaker than the previous fixing of 6.8525.
Analysts said Thursday's fixing was set at a firmer level than their models had suggested.
Chinese authorities are widely believed to have been involved in a sharp spike in offshore yuan funding costs earlier this month to keep the currency from breaching the psychologically important 7 to the dollar level. But it is still trading at more than eight-year lows.
The unexpectedly sharp onshore cash pinch comes despite central bank injections of a net 1.035 trillion yuan ($150.87 billion) through open market operations so far this week, nearly 10 times the amount it injected last week.
"Companies' quarterly payments starting Jan.16 and seasonal cash demand are the key factors draining money out," said a liquidity trader at a Chinese bank in Shanghai.
Some market players said the support by the central bank was barely meeting increased demand in the market.
"The PBOC's injection is not enough," said Gu Weiyong, chief investment officer at bond-focused hedge fund Ucom Investment Co.
Gu added that the situation was not being helped by perceptions that regulators would not mind seeing a rise in financing costs this year if it encourages debt-laden Chinese companies to reduce their heavy debt burdens.
The absence of a MLF rollover on Wednesday has also "caused a certain impact", CITIC Securities said in a note on Thursday.
Two batches of medium-term lending facility loans are maturing on Wednesday and Thursday totalling 216.5 billion yuan, according to Reuters calculations.
"We hope the central bank will roll over the maturing MLF loans, but no one knows whether it will do it or not," said the liquidity trader.
Some traders said they heard the cental bank asked commercial banks in the morning about potential demand for MLF loans, but there was no indication if the bank would inject the funds later in the day.
Traders said the crunch could extend past the holiday, noting more open market repos will mature in early February.
Adding to the squeeze, state banks have sold large amounts of dollars and bought yuan in recent months to help shore up the falling currency, draining funds out of money markets.
Commercial banks' net sales of foreign currency rose in December to the highest since January 2016, the foreign exchange regulator said on Thursday. The central bank sold $46.1 billion of foreign exchange in the same month.
In offshore markets, the yuan was 0.3 percent firmer than onshore at 6.833 per dollar.
Highlighting investors' strongly bearish views on the yuan, offshore one-year non-deliverable forwards contracts (NDFs) traded at 7.105, 3.5 percent weaker than the midpoint. NDFs are considered the best available proxy for forward-looking market expectations of the yuan's value.
($1 = 6.8602 Chinese yuan renminbi)
(Reporting by Winni Zhou and John Ruwitch; Editing by Kim Coghill)