Snap Analysis: China stocks seen sliding further on PBOC move

By Lu Jianxin and Karen Yeung

SHANGHAI (BestGrowthStock) – China’s hike in bank required reserves will likely hit domestic stocks, especially financial shares, but the move should only have a short-term impact as the country’s central bank scrambles to absorb still ample liquidity in the banking system.

The surprise move, the second in two months, is viewed as an attempt by the People’s Bank of China to start immediately removing the 604 billion yuan ($88 billion) of funds pumped into the system before the long holiday, with an eye on still robust bank lending so far this year.

But the reaction is unlikely to be as sharp as that in overseas markets, which have been spooked by worries that China is hitting the brakes too hard to slow its fast-growing economy.

Bond investors are see taking the move in stride as liquidity remains ample in the system.

The PBOC lifted the reserve requirement ratio for major banks by 50 basis points to 16.5 percent in a move that will take effect on February 25.

* China’s benchmark Shanghai Composite Index could fall around 5 percent in the week starting February 22 as retail investors turn nervous about yet another quicker-than-expected step in monetary policy tightening, possibly a precursor to a hike in official benchmark deposit and lending rates.

* The reserve requirement increase will freeze about 300 billion yuan and may pull more funds away from the stock market.

* The Shanghai Composite has slid 8 percent this year due to the policy tightening steps, making among the worst-performing major markets and one factor in the broad drop in Asian shares. The index was up 1 percent on Friday before the surprise move.

* The Shanghai Composite’s 90-day correlation with the MSCI index of Asia-Pacific shares outside Japan is 0.77 and the one-year correlation is 0.90, suggesting any drop could also knock down regional equities.

* For a graphic on the Shanghai Composite and the 30-day moving average of benchmark repo rates, click on: http://r.reuters.com/pus29h

* The move Chinese bond yields will more depend on how aggressive the PBOC drains liquidity in its open market operations right after the holiday.

* China’s government bond yield curve is expected to flatten slightly, with short-term bill and bond yields seen rising about 5 basis points and outpacing any rise in long-term yields.

* The liquidity situation in the bond market has not been affected too much by the PBOC’s tightening. Heavy inflows, partly coming from the recovery in China’s trade surplus and hot money making its way into the country, have offset the PBOC’s hefty fund drains.

* So far the PBOC’s fund absorptions have barely kept pace with the money coming back into the system from maturing central bank bills.

* One key is whether the central bank mops up a large amount of money via open market operations in the week after the holiday, together with hikes in auction yields of bills. If so, short-term yields will spike.

* The long end of the curve is still unlikely to move much as institutional investors understand better than retail investors that an interest rate increase could still be weeks, if not months, away.

* Spot yuan is not expected to move much from levels near 6.83 against the dollar as the government appears unwilling to change its stable yuan policy for now as it awaits further signs of a recovery in exports, even after a jump in December and January.

* One-year yuan non-deliverable forwards (NDFs) are also expected to show little reaction, with the recent Sino-U.S. tensions hardening views that China may become more stubborn in keeping the yuan on a tight leash.

Investment Analysis

($1=6.83 Yuan)

(Editing by Eric Burroughs)

Snap Analysis: China stocks seen sliding further on PBOC move