China yield curve is steepest in two years as liquidity swells

China’s yield curve has become the steepest in two years as a combination of flush liquidity and speculation the central bank will keep policy accommodative pushes down rates on shorter-maturity debt.The extra yield on the nation’s 10-year bonds over one-year securities widened to 93 basis points this week, the most since June 2020, and up from as little as 45 basis points in December. At the same time, longer yields are being kept from falling due to expectations for an economic recovery and the prospect of additional debt issuance.The nation’s shorter bonds have surged since the start of July as a consumer boycott of mortgage payments has fuelled speculation the People’s Bank of China (PBoC) will delay any plans to tighten liquidity. The securities have also rallied after a report last week showed gross domestic product slowed to 0.4% last quarter, far below the nation’s 5.5% annual growth target. The PBoC responded this week by adding liquidity into the financial system for the first time since June through raising the size of its daily short-term cash injection to 12bn yuan ($1.8bn) on Monday from 3bn yuan. The steeper yield curve may be implying very flush front-end liquidity and expectations of more tolerance from the PBoC, said Albert Leung, a strategist at Nomura International in Hong Kong. Meanwhile, investors appear hesitant to add longer duration due to some expectations of a growth improvement and higher bond supply, he said.The steepening of the yield curve in the world’s second-largest economy is almost in polar opposition to what is happening in the biggest. Large swathes of the US curve is inverted amid rapid Federal Reserve interest-rate hikes and surging inflation.Cash levels in China’s economy may swell even further as weak demand for borrowing leaves banks with abundant funds, some of which will be funnelled into the debt market. Data showing credit expanded in June is being questioned as corporates and home buyers have few reasons to increase borrowing amid a property-market slump. The overnight repurchase rate - a gauge of borrowing and bond investment leveraging costs among lenders - fell to an 18-month low last week, while the seven-day gauge is around 1.55%, well below the PBoC’s anchoring policy rate of 2.10%.“The repo rates are already at this year’s bottom range but it could stay at the current level for longer, at least till mid-August when more PBoC policy loans matures,” said Zhaopeng Xing, senior China strategist, Australia & New Zealand Banking Group Ltd in Shanghai. “Liquidity will be kept loose to mitigate financial risks.”Turnover for the overnight repo jumped to a record 5.96tn yuan on Monday as financial institutions ramped up interbank borrowing. Local investors seeking returns for their abundant cash holdings are buying other short-tenor assets as well, pushing down yields on one-year bonds issued by banks and other corporates.“It is unlikely that the PBoC will tighten monetary policy,” Morgan Stanley strategists including Min Dai in Hong Kong wrote this week in a research note. “We continue to be bullish on China rates” as liquidity remains abundant, they said.