MONEY MARKETS-China yields climb on fears of higher rates

* Bond yields hover below 2-year peak as more rate hikes seen

* Cash conditions still ample in the money market

* Players gear up for tighter liquidity, rates rise

By Saikat Chatterjee and Lu Jianxin

HONG KONG/SHANGHAI, Nov 8 (BestGrowthStock) – Chinese bond yields
rose near a two-year high on Monday in anticipation of consumer
price inflation data that is expected to cement the case for more
policy tightening.

Another round of rate hikes by the People’s Bank of China
(PBOC), after a surprise 25 basis points (bps) increase in
deposit and lending rates in October, may trigger a scramble out
of risky assets globally, and suggest that authorities are truly
stepping up their battle against inflation.

The selloff in the bond market was in sharp contrast with
money market rates, which reflect abundant cash circulating
around the financial system, and the seven-day repo rate
(CN7DRP=CFXS: ), a barometer for interbank liquidity, is hovering
near seven-month lows.

An aggressive round of monetary easing by the U.S. Federal
Reserve last week has also increased expectations of accelerating
inflation and consequently higher interest rates.

“The general belief that the PBOC’s rate hike last month may
have been the last for the year has changed and players now are
getting worried about rising rates,” said a senior trader at a
foreign bank in Shanghai.

The 5-year government bond yield (0#CNBMK=: ) was up to 3.10
percent compared with 2.79 percent late on Friday. The yield has
risen 30 bps over the past week and hit 3.19 percent last
Thursday, its highest since October 2008.

October’s hike gave the first signal the government has ended
its two-year “appropriately loose” monetary policy put in place
in late 2008 and even though interest rates have started rising,
mounting inflation pressures will continue to keep real interest
rates in negative territory for a while.

Data this week is expected to show October’s consumer price
inflation accelerated to 4 percent — its highest level in two
years. For a preview, see [[ID:nTOE6A305I].

In contrast, China’s one-year fixed yuan deposit rate is
just 2.5 percent even after last month’s rate increase, meaning
real interest rates are negative.

Some traders said that a pickup in inflation pressures has
prompted some investors to pull out some funds from bonds and
park them in the rising stock market.

The Shanghai Composite (.SSEC: ) has nearly recouped all its
losses since the clampdown on property speculation in April and
is trading near a seven-month peak.

In the money market, liquidity was ample, driven by capital
flows and funds from a booming property market, but conditions
may start to tighten if authorities step up their fund draining
operations via weekly auctions.

On Monday, the weighted average seven-day government bond
repurchase rate rose by 2 bps to 1.6342 percent, trimming a 40
bps fall last week.

Some signs are appearing of tighter lending conditions,
however.

Spreads between one year swaps and the seven-day repo rate,
the floating leg used in such swap contracts, have already
started widening with the spread at 79 bps on Monday, not far
away from a 2010 peak of 82 bps hit on Friday.

On a outright basis, one year swaps (CNYIRS: ) are up 10 bps in
the last week, rising for the second consecutive week.

“If CPI data jumps above 4 percent, we may see the PBOC
raising rates and tightening liquidity simultaneously,” a trader
said.
(Editing by Kevin Plumberg and David Chance)

MONEY MARKETS-China yields climb on fears of higher rates