China Has Its First Taste Of "VaR Shock" As PBOC 14 Day Repo Sparks Treasury Dump

Chinese Treasury futures tumbled overnight, posting their sharpest fall in three months, after the local market was spooked when the PBOC surprised bondholder by hinting it could avoid broad easing and instead may bring back a far less powerful tool. Overnight, the People's Bank of China asked banks about demand for 14-day reverse bond repurchase agreements for the first time since February, suggesting it may be expanding its strategy of using targeted, short-term injections rather than cutting interest rates or banks' reserve requirements (RRR).

As a result, and confirming once again that fundamentals are dead even in China where only liquidity injections matter just like across the entire "developed" market, the price of Chinese 10- Y treasury futures tumlbed 0.38%. This was also China's first glimpse of what a VaR shock in government bonds will look like once yields spike from recent record lows.

A senior trader at a major Chinese state-owned bank in Shanghai, cited by Reuters, said that "the market interprets the move as another sign that the central bank won't cut interest rates and RRR for now as it injects more short-term money into the banking system."  He added that the PBOC announcement "is likely to set a floor for the fall of the yields of government bond futures, and thus investors sold the futures on the news."

The People's Bank of China (PBOC) has relied on issuance of seven-day reverse repos in daily open market operations this year, injecting cash on a regular basis to manage short-term money supply. The adjustment may imply the PBOC is preparing to extend the tenor of its short-term money management strategy.

While many have been expecting the PBOC to ease anew, with both housing data and the broader economy once again rolling over while trade data remains subdued, the PBOC has not cut RRR since March, and has not cut long-term guidance interest rates since October.

Still, while the economy urgently needs more easing, if only judged by the recent collapse in Chinese yields, the PBOC knows that more aggressive monetary policy easing will put unwanted additional pressure on the yuan currency, which is near six-year lows, and risk more capital outflows.

However, now that it has tipped its hand, a new risk emerges: VaR shock, something China has not experienced yet.

While that has yet to manifest itself, as Reuters adds, policymakers have clearly grown more concerned recently about the risks of prolonged, debt-fuelled stimulus, and appear to have turned their focus to more government spending instead.

Money markets were mixed after the PBOC's move, with the volume weighted average of the 14-day repo down just two basis points (bps) to 2.7 percent and the seven-day weighted average rate up six bps at 2.40 percent.  Although the 14-day repo rate has been moving higher in recent days, the weighted average remains far below its recent peak of 2.82 percent in late July.

With the central bank conducting seven-day reverse repos on a nearly daily basis, the benchmark seven-day rate has remained steady for most of 2016, but the 14-day has been more volatile.

So far in 2016, the PBOC has injected a net 654.3 billion yuan ($98.44 billion) through open markets year to date by the week ending Aug 20. It has also injected funds through medium-term lending facilities which allow it to channel money to more vulnerable sectors such as agricultural firms or small businesses.

Finally, China has also injected trillions in bank debt, both in the form of conventional loans and shadow debt, neither of which have merely slowed down the decline.