China Announces RRR Cut Of At Least 50 bps; First Since February 2016

In a sign that China"s ongoing attempts to delever (and decelerate) the economy may have gone a bit too far, on Saturday morning China’s central bank announced a targeted reserve requirement ratio (RRR) cut, its first since February 2016 and which will go into effect in 2018, in an attempt to boost lending to struggling smaller firms and energize China"s lacklustre private sector, Xinhua reported. 

The People’s Bank of China said on its website that it would cut the reserve requirement ratio for some banks that meet certain requirements for lending to small business and the agricultural sector. According to the PBOC, the vast majority of China’s banks would be eligible for at least a 50 bps cut to their required reserve ratio. As a reminder, the RRR is the amount of cash as a percentage of deposits that banks must park at the central bank as reserves. The current rate for major banks was set at 17.0% after the last general RRR cut that took effect in March 2016.

The PBOC explained that the reserve requirement rate will be cut by 50 bps for banks whose loans to the targeted groups account for 1.5% of their outstanding loan balance or their newly added loans for the previous year. A much higher bar is set for a further 100 bps cut: 10% of loans must be to the designated “inclusive finance” groups, the PBOC said. Banks that meet the 10%  requirement will see their RRR cut by 150 bps.

The PBOC also said the move was made to encourage more small loans - those under 5 million yuan - to small firms, loans to individual proprietors and lending that supports agricultural production, innovation, the poor and education.

As the following chart show, the targeted RRR cut which is meant to stimulate credit creation by smaller banks comes at a time when smaller bank lending has slown substantially as a result of the ongoing crackdown on shadow banking products.

While the central bank explained that the "targeted" RRR cut is a structural adjustment that does not change the country"s overall monetary policy stance, stressing that it would continue to implement "prudent and neutral" policy to guide reasonable credit and financing growth, analysts at Lianxun Securities said that "the size of the cut is big, it covers all big banks, and 90 percent of small and mid-sized banks. Conservatively we estimate 700 billion yuan in liquidity could be freed up."

Perhaps more notably, analysts observed that the cut was different from previous changes to RRR in that it was a “delayed” cut that will not go into effect until next year, which could lead to disappointment for a banking sector that has already seen significant liquidity withdrawn in recent weeks.

“Clearly, the market will be disappointed as this cut will not help ease the liquidity conditions in the onshore banking system in the short term,” Zhou Hao, a Singapore-based analyst at Commerzbank, wrote in a note after the announcement.

The RRR cut will likely not come as a surprise as China’s cabinet, gearing up for the most important Communist party Congress in 5 years starting next month, had recently flagged a possible move, saying "the government would take a number of measures, including tax exemptions and targeted reserve requirement ratio cuts to encourage banks to support small businesses."

The policy action is in line with ongoing attempts to delever the economy and encourage more targeted lending to more vulnerable sectors of the economy, even as the government tries to cut down on speculative investment in the financial sector and property and rein in a rapid buildup in overall corporate debt. However, the RRR cut is departure from the PBOC"s recent approach of setting policy using new tools such as short- and medium-term lending facilities for a similar purpose....

... as well as daily changes to interbank liquidity via reverse repo open market operations.

Lianxun Securities also said the RRR cut would help to offset negative impacts to smaller firms from strict environmental protection measures and capacity cuts, while also offering some liquidity relief to small and mid-sized financial firms. Additionally, the move comes amid increasingly more aggressive attempts by China to delever its shadow banking system, which has plateaued over the past year.

As Deutsche Bank noted several days ago, in China"s latest monthly credit data report "the financial deleveraging campaign has continued to make progresses: banking assets growth softened further; loan and TSF beat estimates but the overall credit growth actually moderated; shadow banking size was shrinking while loan growth stayed resilient. As such from the financial system’s perspective we see improving transparency and lower liquidity risks. While the deleveraging has contributed to a modestly slower economy, the growth momentum is in line with our house view."

That said, DB said that "we do not foresee policies to ease and we expect the deleveraging to carry on orderly," so one wonders how today"s significant easing will impact the German bank"s outlook on China"s economy.

Separately, to offset the shrinkage in China"s shadow banking sector, in February the PBOC extended a preferential programme that allows financial institutions that support rural finance and small enterprises to apply for a lower required level of cash reserves.  But despite still-strong credit growth nationwide, many small businesses and farmers remain in desperate need of funds and do not have easy access to ample cheap credit that state-run firms enjoy.

Also on Saturday, the central bank said it will maintain prudent and neutral monetary policy and use multiple monetary policy tools to keep liquidity basically stable. The statement, which came after the third quarter meeting of the PBOC’s monetary policy committee, said "China will continue with interest rate and exchange rate reform while keeping the yuan basically stable."

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Finally, also on Saturday, China reported that its manufacturing PMI rose to 52.4 in September - more than the 51.5 expected and the highest print since April 2012 - as big factories ramped up faster than smaller ones, presumably a last piece of window dressing to show host "strong" the economy is ahead of the pivotal Communist Party meeting. The National Statistics Bureau attributed the surge to improving demand from domestic and overseas markets and to consumer-goods makers accelerating production ahead of a weeklong national holiday starting October 1. Some economists also said activity picked up thanks to production from Chinese exporters for the Christmas season and manufacturers bringing production forward to beat a government crackdown on pollution.

Ironically, as China"s official manufacturing survey, which focuses on larger SOEs, came out scorching hot, a private measurement of factory activity, which more closely tracks smaller private companies, weakened. The Caixin China manufacturing purchasing managers’ index slipped to 51.0 in September from 51.6 in August, as new orders and output increased at a softer rate than the previous month, said Caixin Media Co. and research firm Markit.

Operating conditions in China"s manufacturing sector softened in September, dragged down by the weakest rise in new business in three months and an easing in output to the lowest level since June, according to the latest Caixin Manufacturing Purchasing Managers" Index (PMI) released Saturday. The headline manufacturing PMI fell to 51.0 in September from 51.6 in August but remained above the 50 break-even mark for fourth consecutive month, according to data compiled by IHS Markit for Caixin.

Readings above 50 indicate expansion in the manufacturing sector while readings below 50 indicate contraction. The higher the PMI reading above 50, the faster the expansion in the sector. The lower the reading below 50, the faster the contraction.

The slowdown in the Caixin index -- which focuses on smaller and medium-size companies -- was in contrast to the sharp rise in the official manufacturing PMI jointly released today by the China Federation of Logistics and Purchasing and the National Bureau of Statistics. The CFLP/NBS PMI came in above expectations at 52.4 in September, the  highest level since April 2012, due mainly to robust input and output prices.

The Caixin index showed that new business expanded at a slower pace due to the weak demand. "Notably, new export work increased only marginally during the latest survey period," Caixin said.

The chart below shows the latest divergence between the two series:

Lu Zhengwei, an economist with Industrial Bank, told the WSJ that the government crackdown to curb pollution falls heavier on smaller manufacturers, which usually have poorer emissions controls, hence the divergence between the gauges. However, in light of the ongoing plunge in China"s credit impulse and the recent miss and slowdown across all major economic indicators, including industrial output, retail sales, foreign trade and fixed-asset investment, it is clear that the economy has begun to cool. 

In response, the governing State Council recommended this past week that the amount of reserves big banks must set aside with the central bank should be lowered, provided they meet certain criteria on lending to small and private businesses. Zhou Jingtong, an economist with Bank of China , said it was a good time to lower the reserve requirement for some big banks to prevent the economy from decelerating too sharply.

That"s precisely what happened this morning.

Is China Trying To (Slowly) Burst Another Stock Market Bubble?

The pressure point in Asian stock markets this week has been the decline in Chinese equities (the biggest weekly drop in 4 months).

Despite a stellar performance of the economy the outlook for the Shanghai Composite Index isn’t promising as the government is taking advantage of better growth to spur deleveraging.

For a market relying more on liquidity than fundamentals, China’s worsening monetary conditions index suggests tough times ahead...

As a reminder, the Shanghai Composite Index, notorious for its wild swings over the past two years, has gone 86 trading days without a loss of more than 1% on a closing basis, the longest stretch since the market’s infancy in 1992.

 The last 4 days have highlighted the unusual effect in Chinese stocks.. each time the Shanghai Composite dropped over 1% (red dotted line) it was miraculously lifted to ensure it closed with a loss less than 1%...

As Bloomberg reports, authorities favor a steady stock market because it helps companies fund investment and repay debt by issuing new shares, which could help boost economic growth, according to Yin Ming, a vice president at Baptized Capital in Shanghai.

“The national team is behind it,” Yin said. “State funds will likely continue to be a market stabilizer.”

So one wonders, is China desperate to delever the speculative fervor in their markets... but do it just 1% at a time? Can the "market" really be that well centrally planned? We will see...

If the 6-month lag in Chines commodities is anything to go by, the breakdown in Chinese stocks is nowhere near over...

China 'Shadow Banks' Crushed As Liquidity Costs Hit Record High

During the so-called Chinese Banking Liquidity Crisis of 2013, the relative cost of funds for non-bank institutions spiked to 100bps. So, the fact that the "shadow banking" liquidity premium has exploded to almost 250 points - by far a record - in the last few days should indicate just how stressed Chinese money markets are.

While interbank borrowing rates have climbed across the board, the surge has been unusually steep for non-bank institutions, including securities companies and investment firms. They’re now paying what amounts to a record premium for short-term funds relative to large Chinese banks, according to data compiled by Bloomberg.

The premium is reflected in the gap between China’s seven-day repurchase rate fixing and the weighted average rate, which, by Bloomberg notes, widened to as much as 2.47 percentage points on Wednesday after some small lenders were said to miss payments in the interbank market. Non-bank borrowers tend to have a greater influence on the fixing, while large banks have more sway over the weighted average.

"It’s more expensive and difficult for non-bank financial institutions to get funding in the market," said Becky Liu, Hong Kong-based head of China macro strategy at Standard Chartered Plc. “Bigger lenders who have access to regulatory funding are not lending much of the money out.”

Without access to deposits or central bank liquidity facilities, many of China’s non-bank institutions must rely on volatile money markets. As Bloomberg points out, The People’s Bank of China has been guiding those rates higher in recent months to encourage a reduction of leverage, while also stepping in at times to prevent a liquidity crunch.

The PBOC responded to this week’s jump in borrowing costs by making an unscheduled injection of hundreds of billions of yuan on Tuesday, and it followed that with another addition of cash through daily open-market operations on Wednesday.

"The PBOC is allowing smaller lenders to miss payments in order to force financial institutions to de-leverage," said Harrison Hu, chief greater China economist at Royal Bank of Scotland Group Plc in Singapore.

"But it will keep a fine balance. It doesn’t want the pressures to become out of control. There’s a possibility that the PBOC will directly inject funds in smaller banks, if the cash shortage continues.”

As Goldman noted, the rate surge reflects a combination of:

• A tightening bias by the PBOC. The central bank has shifted policy stance since autumn last year, but the clearer interbank rate rise in recent days suggests that the hawkish bias has stepped up further.


• Diminished clarity of the role of interbank rates in the PBOC’s policy framework. Since mid-2015, interbank rates had been kept largely steady, partly reflecting the PBOC’s efforts to build up a policy rate framework centering on interbank rates. The PBOC has also introduced SLF (standing lending facility), which is understood as a tool to keep volatility in interbank funding conditions low. However, in a signal that deviates from these previous efforts, the PBOC last Thursday tried to dissociate interbank rates from “policy rates”, which the PBOC said should mean benchmark bank lending and deposits rates. The comment appeared to open up a bigger scope for the PBOC to allow interbank rates to move higher (with the possible intention to avoid conflict with its official “stable and neutral” policy stance or potential pushback from other policy authorities).


• The SLF mechanism appears to have not functioned effectively in recent days. There have been occasional breaches of the general 7-day repo rate above the SLF rate (3.35% per PBOC’s official communication, although it was reportedly raised to 3.45% last week). This suggests that SLF has not effectively fulfilled its supposed function of imposing a ceiling to interbank rates. One possible reason is that SLF is accessible only by banks, and much of the spikes of the general 7-day repo rate have been a result of liquidity scramble by NBFIs (which have no SLF access), while banks" interbank funding cost (as measured by DR007; Exhibit 1) has remained more moderate and still below the SLF rate (note that the 7-day repo fixing rate is partly based on funding cost of NBFIs as well). Nevertheless, the apparent lack of effectiveness of SLF in suppressing interbank rate volatility might have weakened the anchoring of the market’s rate expectations in the near term, and such uncertainty could have compounded the liquidity squeeze.


• Continued high interbank repo borrowing by funds. The wide gap of R007-DR007 reflects continued stress imposed by NBFIs, likely particularly funds, on the funding market. Indeed, as of end-Feb, interbank repo borrowing by funds remained high at over 30% of the interbank repo borrowing (Exhibit 2) despite the increased pressure on the commercial viability of repo trades (borrowing via interbank repo to finance long-dated bond holdings).


• Regulatory impact. The PBOC has tightened the prudential requirements (particularly on the growth of banks" balance sheet) under its MPA examination, which is to be conducted at quarter-end. This has likely further contributed to, and amplified the impact of, a tightening in the interbank market.

In total, the interbank rate volatility may remain quite high in the coming days, especially in light of the near-term consideration of MPA examination at quarter-end and the PBOC"s apparent deviation from the previous monetary policy framework. Alternatively, today"s plunge in the dollar may have had a secondary purpose of easing Chinese financial conditions, where the ongoing dollar rally has pushed the local financial sector to the brink of illiquid collapse.

Why China Unexpectedly Hiked Rates 10 Hours After The Fed

As we reported on Wednesday evening, something interesting took place on Thursday morning in Beijing: in a case of eerie coordination, China tightened monetary conditions across many of the PBOC"s liquidity-providing conduits just 10 hours after the Fed raised its own interest rate by 0.25% for only the third time in a decade.

The oddly matched rate hikes, prompted Bloomberg to think back to the mysterious "Shanghai Accord" of February 2016, which took place during the peak days of last year"s global capital markets crisis, and whose closed-door decisions - to this day kept away from the public - prompted the market rally that continues to this day. As Bloomberg wrote, the coordinated "response suggests that pledges by the Group of 20 economies a little over a year ago in Shanghai to "carefully calibrate and clearly communicate" policies may not have been hollow after all."

That said, it was not the first time the People’s Bank of China has acted on the heels of a Fed move. At the peak of the financial crisis, the PBOC cut lending rates after six of its counterparts, including the Fed, had announced a simultaneous rate cut. That October 2008 move enhanced China’s emerging reputation as a global player on the international economic-policy circuit. “Growth divergence is morphing into growth synchronization," said Chua Hak Bin, a Singapore-based senior economist with Maybank. "Policy divergence was also a narrative for those expecting a strong dollar, but that is moving now to policy synchronization.”

Coordinated or not, as of last night financial conditions in China, like in the US, have become incrementally tighter even if both the Chinese and US stock markets failed to respond accordingly.

So, for those curious what China did - after all the days of shotgun Interest rate or RRR moves appear to be on hibernation for the time being - here is a convenient primer from SocGen"s Wei Yao explaining not only the mechanics, but the reason why.

As Yao notes, the PBoC followed the Fed closely, at least timing-wise, and raised the rates on its major liquidity management tools by 10bp across the curve today, earlier than many had expected. After the hikes, the rate on the 7D reverse repo operations - the most critical of all - is now at 2.45%.

The central bank, in its press release, stressed that these interbank rate hikes simply follow the market"s development, thus not true policy rate hikes, and only hikes of benchmark lending and deposit rates count. Nevertheless, it also listed four classical rate-hike reasons for the interbank rate changes: the economic recovery, rising inflation (particularly that of housing), strong credit growth and Fed"s rate hikes.

SocGen"s interpretation of this statement is:

1. The PBoC is responding to the fundamentals of growth, inflation and financial stability. And it is looking through the low food prices, which have suppressed CPI, and paying due attention to domestic asset bubbles and credit growth.


2. But it still prefers a tightening approach so as to match its neutral stance, which means that adjusting interbank liquidity and interbank rates will likely remain the main actions. This may be because the headline CPI is muted after all, or because it has to change its policy rates from benchmark deposit/lending rates to interbank-linked rates sooner or later and so better start practicing now. In any case, it does not want the market to get ahead itself and price in too much tightening, just like the Fed.


3. Fed"s policy and US-China interest rate differentials do play a role in PBoC"s consideration. It may not be a very big role, as offering 10bp for every 25bp from the Fed is at best half-hearted help to the RMB. However, the Fed"s action offered the PBoC a timing to make the move, appearing to support the argument that the interbank rate hikes are “following the market”.

Given PBoC"s latest move and our view that growth stability will stay until the end of 2017, SocGen now expects further interbank rate hikes: 20bp in 2Q, 10bp in 3Q and no change in 4Q.

The equally critical development to watch is the evolution of interbank market rates as resulted from PBoC"s daily liquidity management. The trend of these market rates leads the changes of rates on PBoC"s instruments, thus a more timely indication of PBoC"s intention. Before today"s moves, the 28-day moving average of the 7d repo was already 50bp above the low back in August 2016.

Finally, while China has traditionally shied away from criticizing the Fed using conventional channels, in a surprising editorial in the Economic Information Daily, the authors said that China should be wary of a "spillover effect" from the Fed rate hikes, warning that “selfish” US interest rate policies have historically triggered crises in many other nations, the newspaper says in its front-page commentary. Finally, it warned that frequent Fed rate hikes may have “serious impact” on global economy.

Keep a close eye on tonight"s reverse repo facility: if China is really concerned, it very well may "hike" again.

China Central Bank Admits It Has A Debt Problem, Warns No Easy Solution

It"s a well-known risk, perhaps the biggest to the global financial system: China"s debt is too high, with estimates ranging from 250% to 300% of GDP per the IIF:

And while China has largely ignored, or avoided, discussing the troubling implications of its unprecedented debt load, this changed today when the head of China"s central bank, Zhou Xiachuan finally admitted that it has a debt "problem" saying that corporate debt levels are too high and that "it will take time to bring them down to more manageable levels", underlining what has become the defining battle to put the world"s second-largest economy on a more sustainable footing: keeping GDP growing at 6.5% (or above) while injecting trillions in new debt.

"Non-financial corporate leverage is too high," PBOC Governor Zhou Xiaochuan told reporters at a news conference on the sidelines of the annual parliament session.

Quoted by Reuters, he said that efforts will be made to contain debt levels, including restructuring of firms with heavy debt burdens, alongside a push to reduce excess industrial capacity.  Furthermore, banks will withdraw support for financially unviable firms, he added, repeating pledges by other officials last year to drive such "zombie" firms out of the market.

"I personally think this process is relatively medium-term. It won"t have very obvious results in the short-term because the existing stock (of debt) is very large," he said.

Zhou Xiaochuan, Governor of the People"s Bank of China, attends a news
conference in Beijing China March 10, 2017. REUTERS/Jason Lee

Zhou also said that measures by local governments to cool rising house prices will slow mortgage growth to some degree, but housing loans will continue to grow at a relatively rapid pace. We profiled China"s mortgage debt problem last October when we showed that over 70% of all new loans went to fund mortgages, which in turn now account for a fifth of total Chinese outstanding loans.

According to official data, China"s debt-to-GDP has risen to 277%, up nearly 25% since the end of 2016 when it was 254%, with an increasing share of new credit being used to pay debt servicing costs, UBS analysts said in a note. In other words, China now finds itself in the "ponzi financing" stage of its debt lifecycle, with a "Minsky Moment" approaching fast. 

China"s credit growth has been "very fast" by global standards, and without a comprehensive strategy to tackle the overhang, there is a growing risk it will have a banking crisis or sharply slower growth or both, the IMF warned late last year.

While China"s leaders have pledged to contain debt and housing risks in 2017 after years of credit-fueled expansion, which has been propelled by the need to meet official economic growth targets, this has proven to be problematic with expectations that China will have to issue over $3 trillion in debt in the coming year, and as a result most analysts remain doubtful over the government"s commitment to follow through on potentially painful reforms, especially if growth falters.

Despite his dour admission, according to Reuters Zhou, who took control of the PBOC in 2002 and is the under the radar architect of China"s financial reforms, was seeimingly in a very good mood, smiling and engaging with the deputy governors beside him as well as news journalists throughout  the news conference. 

China"s corporate debt has soared to 169 percent of gross domestic product (GDP), according to figures from the Bank for International Settlements. China needs to first stabilize its overall debt levels before gradually reducing them, deputy central bank governor Yi Gang said at the same briefing.

* * *

Perhaps more troubling to China"s liquidity addicts, Zhou said that the central bank"s tilting towards a neutral stance would help with China"s supply-side reforms, reiterating that it would be "prudent" while reminding markets that the central bank has many policy tools at its disposal. In recent months, the PBOC has cautiously moved to a modest tightening bias in a bid to cool explosive growth in debt and discourage speculative activity, though it is treading cautiously to avoid hurting economic growth. It surprised financial markets by raising short-term interest rates in January and February by marginal amounts, and is expected to bump them higher in coming months, though an increase in its benchmark policy lending rate is seen as unlikely this year.

Over the weekend, Beijing set a more modest economic growth target of "around 6.5%" this year, easing from last year"s 6.5-7 percent range, ostensibly to give policymakers more room to focus on financial risks. The economy ultimately expanded 6.7 percent last year, but much of the growth came from record lending by state banks and higher government spending on infrastructure, which has helped revived the long ailing and heavily indebted industrial sector.

Still, despite promises of deleveraging, Beijing"s trajectory remains much of the same: bank lending in January was the highest on record and it did not slow as much as expected in February.

"If there is too much money in the economy, in fact it is very harmful to the economy as it might lead to problems such as higher inflation and asset price bubbles," Zhou said.

While admission of the problem is a key first step, few have any faith that China will take the necessary, and very painful, next steps to remove the debt froth that has kept not only China, but the global growth dynamo turning, especially now that the global credit impulse, as UBS demonstrated two weeks ago, has tumbled and is on the verge of turning negative.

Our global credit impulse (covering 77% of global GDP) has suddenly collapsed: as the chart below shows the "global" credit impulse over the last 18 months is essentially mainly China (the green shaded bit), which even now is still creating new credit at an annualized rate of around 30pp of (Chinese) GDP. But the credit impulse is the "change in the change" in credit and even the Chinese banks could not sustain the recent extraordinary pace of credit acceleration. As a result: whereas back in Jan "16 the global credit impulse was positive to the tune of 3.8% of global GDP (of which China comprised 3.5% of global GDP) it has now fallen back to -0.1% of global GDP (China"s contribution is -0.3% of global GDP).

Should the impulse turn negative outright, the transition would have dire implications for the global growth, and reflation, cycle.

China Drains CNY715 Billion In Liquidity After Fifth Day Without Reverse Repo

What a difference three weeks makes. On January 18, heading into the Lunar New Year holidays, we reported that the PBOC had injected a record 1.04 trillion yuan into the liquidity-starved banking system in an attempt to avoid a liquidity crunch as telegraphed just days prior by dramatic surge in short-term repo rates.

Since then, however, between the end of the holidays, and the stated Chinese intention to tighten the monetary system, things have changed drastically.

First of all, last Friday, China announced an unexpected tightening of policy when it raised rates on 7, 14 and 28-day reverse repos by 10bps to 2.35%, 2.50% and 2.65% respectively. That was first increase in the 28-day contracts since 2015 and since 2013 for the other two tenors. As this was the first working day following the New Year holiday in China, it was a decent "statement of intent" by the PBoC.

At the same time, as we explained on Sunday, in a parallel tightening eipsode, the PBOC also increased Standing Lending Facility rates on overnight/7-day/1-month tenors by 35bp/10bp/10bp (to 3.10%/3.35%/3.7%), sending Chinese government bond futures sliding as fears rose that China is actually serious about tightening this time.

Then on Thursday morning, an article in China"s Securities Journal said that China may keep tightening monetary policy this year amid pressure from yuan rate stabilization, financial de-leveraging, curbs on real estate and faster inflation. In other words, China may have reached the phase where it admits it has a problem, and is ready to do something about it. What was notable is that the article hinted that while even more could be done, the economic basis and inflation situation don’t yet support China entering interest rate hike cycle.

Translation: if inflation picks up more from here, the PBOC will use the shotgun approach and hike rates. For now however, the piece concluded that the central bank is focusing more on price tools, which means "an increase in open market rates may be considered guidance."

And sure enough, 20 days after the PBOC had injected a record CNY1+ trillion in liquidity, it is now draining it just as fast, and as the PBOC just reported, the Central Bank did not conduct any Reverse Repo open market operations for the fifth consecutive trading day "in order to maintain a stable level of liquidity in the interbank market", the PBOC said in a statement on its website.

With CNY150 billion of reverse repos maturing today, the PBOC"s lack of action had the effect of draining CNY150 billion from the market today.

The PBOC also added that "while the central bank has started to gradually drain liquidity from the interbank market after the end of the Chinese New Year holiday, liquidity is still at an adequate level" repeating the explanation it used in the past three days.

According to Market News, the market sees the lack of open market operations as a clear signal of tighter monetary policy. Furthermore, the consecutive stops of OMOs show PBOC"s bias for a prudent tilted to neutral monetary policy in a bid to prevent risks and reduce leverage ratio, said Ming Ming, chief analyst with CITIC Securities in a research note.

In total, the PBOC has drained a total of CNY715 billion in liquidity so far this week, primarily as a result of maturing reverse repos which the central bank refuses to roll over. A total of CNY80 billion in reverse repos will mature later this week and the market will be watching the PBOC"s response closely. Should it perceive that the PBOC has withdrawn too much liquidity, another liquidity tantrum is inevitable.

It's Time To Start Worrying About China Again

One year ago, S&P futures would tumble the second a flashing red headline noted that things involving China, the Yuan, or the PBOC were not playing out as expected. One year later, the market has forgotten it ever cared about the world"s biggest debt bubble.

However, the time may have come to once again start worrying about China.

With China coming back from its week-long holidays last Friday, a very important event took place under the radar, and was largely missed by the broader investing public masked by the relentless noise out of Washington and the January payrolls report: China has resumed tightening. For those who missed it, here is a recap of what we said first thing on Friday:

"this morning China announced an unexpected tightening of policy when it raised rates on 7, 14 and 28-day reverse repos by 10bps to 2.35%, 2.50% and 2.65% respectively. That’s the first increase in the 28-day contracts since 2015 and since 2013 for the other two tenors. Keep in mind that this is the first working day following the New Year holiday in China, so it seems to be a decent statement of intent by the PBoC.

Additionally, the SLF rate was increased to 3.1 percent from 2.75 percent. The implicit tightening sent Chinese stocks lower, with the Shanghai Composite closing down 0.6%, and accelerating the selloff in Chinese 10Y government futures.

While China"s first effective tightening in two years largely slipped between the market"s cracks, the press is starting to pay attention ("China’s central bank raised key interest rates in the money marketFriday, reinforcing a shift toward tightening monetary policy aimed atdeflating asset bubbles and reducing long-term financial risk.” MarketWatch, Feb 3; “China’s surprise increase in interest rates on medium-term loansweighed on bond prices. …Some traders were clearly rattled by China’s first-ever increase in interest rates for its medium-term lending facility (MLF) loans, which was seen as signaling that short-term funding costswill move higher eventually as authorities try to cool an explosive increase in debt.” Reuters, Jan 25).

To be sure, Friday"s explicit tightening followed several similar implicit actions by the government, which has been flashing warnings it would tighten and/or engage in deleveraging to slow down China"s stupendous ascent toward 300% debt/GDP, including a sharp slowdown in government spending which has collapsed from 20% one year ago to only 8% Y/Y at the end of 2016, the first slowdown in home price acceleration in 19 consecutive months following Beijing eagerness to pop China"s housing bubble, the recent hike in auto sales taxes from 5% to 7.5%, and so on.

China"s sudden tightening move, which according to many will end the single biggest catalyst for the global reflation/growth story of 2016, namely China"s dramatic debt-fueled growth impulse which in turn then spilled over to the rest of the world, has already been dubbed as "The Most Important Unnoticed Global Event" by the likes of Cornerstone.

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And since China"s push to tighten financial is really that important, here again courtesy of Goldman, is a full recap of what happened, why it matters, and a breakdown of all the key Chinese acronyms to keep an eye on in the coming days as the PBOC is very likely to continue expanding its tightening bias into other monetary conduits.

PBOC raised interest rates on key monetary operations, further reinforcing tightening bias

On Friday, PBOC increased interest rates on OMOs (open market operations) by 10bp and on SLF (standing lending facility) by 10-35bp--shortly following the rise in interest rates on MLF (medium-term lending facility) less than two weeks ago. We believe that the PBOC will retain its tightening bias in the near term as the underlying financial-leverage and macroeconomic arguments for tightened monetary policy have largely remained.

Main points:

Daily OMOs have been a key PBOC tool to manage interbank liquidity conditions.

The central bank on Friday increased the interest rates on reverse repo OMOs (liquidity injections) of 7/14/28-day tenors by 10bp (to 2.35%/2.50%/2.65%). The last time the PBOC raised OMO rates was more than two years ago in 2014.

The PBOC also increased SLF rates on overnight/7-day/1-month tenors by 35bp/10bp/10bp (to 3.10%/3.35%/3.7%).

SLF is collateralized lending by the PBOC to financial institutions which request funding (see Appendix table for key PBOC toolkit). SLF usage has been relatively small (e.g., in January, the turnover and outstanding balance of SLF were well below RMB 100bn, while those of OMOs were about 20 times larger at roughly RMB 2tn). But given that SLF is likely tapped only when the interbank funding conditions are particularly tight, the SLF rate increase should still matter for the marginal funding cost in the system. The asymmetrically large increase in the overnight SLF rate will likely be an encouragement for financial institutions to lengthen the maturity of their interbank funding (we estimate that small commercial banks’ interbank repo borrowing has an average maturity of only about 2 days).

Media reports also suggest that the PBOC has increased SLF rates further by 100bp for those banks that fail Macro-prudential Assessment (MPA) requirements. This has not been confirmed by the PBOC, however. As background, the PBOC set up MPA at the beginning of 2016 through which the central bank may fine-tune each individual bank’s required reserve ratio (RRR) on a quarterly basis depending on its performance based on several prudential metrics (see here for further official details of MPA).

The underlying financial-leverage and macroeconomic arguments for tightened monetary policy have largely remained. We continue to expect that the PBOC’s tightening bias will remain unless either i) there is a clearer deleveraging in the interbank funding market, and/or ii) economic activity slows materially.

Appendix table: OMOs and SLF play different roles in PBOC’s policy toolkit

PBOC toolkit