China Will Suspend Open Market Operations Tomorrow In Response To Liquidity Freeze

Merely minutes after reporting the third daily surge in the SHIBOR we see a Dow Jones update which confirms that this liquidity escalation is far more serious than a merely transitory jump in short-term lending rates. Per DJ: "China's central bank said Wednesday it will suspend its regular open market operation Thursday, in an apparent response to the tight liquidity conditions in the banking system." As a result of the just reported 7 Day SHIBOR hitting 8.81%, the highest since October 2007, the PBoC will not conduct regularly scheduled open market operations tomorrow when it offers three-month paper, to mop up excess liquidity in the country. "The PBOC sold CNY1 billion ($154.6 million) worth of one-year bills at 3.4019% in its operation Tuesday, after leaving the rate unchanged at 3.3058% for the past 11 weeks. On Thursday last week, the PBOC lifted the rate on its three-month bills by eight basis points to 2.9985%, the first increase on the three-month central bank bill yield since early April. "It is difficult for the central bank to find enough demand for its short-term bill offering amid the severe liquidity squeeze in the money market. If it persisted with the three-month bill offering tomorrow, the yield would jump again, adding pressure to the central bank's operating costs," said a Shanghai-based trader with a local bank."

Why is this important? Because as is by now well known, China is Europe's white knight, and Chinese banks, likely with the assistance of the PBoC, have been buying up European (and Japanese bonds). Yet will it be able to do so in light of the lock out of banks from overnight liquidity? This is currently unknown, although speculation that June inflation will be even higher than May's, likely have ominous implications for future liquidity as more rate hikes are imminent.

And if the liquidity freeze is already affecting open market operations, it is very much unclear what this means for general fund flows within the Chinese economy. One factor that can provide a brief respite is the maturity of CNY83 billion in bills and repos this week, which will inject some much needed liquidity in the market.

Keep a close eye on the SHIBOR: if China ends up needing Central Bank assistance in the unsecured lending market, it will destroy all credibility of the Chinese "White Knight" scenario.

h/t London Dude Trader