No happy New Year in China as currency, liquidity fears Loom

China bulls could be facing a grim New Year’s eve. The first day of 2017 is when an annual USD50,000 quota to convert the yuan into foreign exchange resets, stoking concern there will be a rush to sell the local currency. With tax payments and a regulatory assessment also tightening liquidity in the money market toward year-end, January may bring scant relief as lenders prepare for stronger cash demand before Lunar New Year holidays, which are only a month away.

China’s markets are seeing renewed pressure this month as the Federal Reserve projects a faster pace of rate increases for 2017 and its Chinese counterpart tightens monetary conditions to spur deleveraging and defend the exchange rate. The declines are capping off a tough year for investors during which bonds, shares and currency all slumped.

“You have Chinese New Year quite early, and because of that one-month window, most of the banks will try to lock the money in a three-month cycle,” said Arthur Lau, Hong Kong-based head of Asia ex-Japan fixed income at PineBridge Investments. “The current situation in the bond market is partly because of year-end and because of Chinese New Year.”

The week-long Lunar New Year holidays are traditionally a time when people give out cash gifts and companies pay employee bonuses.

China’s 10-year government bond yield has surged 21 basis points in December, poised for its biggest monthly increase since August 2013, and its first annual gain since that same year, Chinabond data show. The yuan’s 6.6 percent decline in 2016 puts it on course for its worst year since 1994, while the Shanghai Composite Index is headed for its largest drop in five years.

The three-month interbank rate known as Shibor rose for a 50th day, its longest streak since 2010, to an 18-month high yesterday. The overnight repurchase rate on the Shanghai Stock Exchange jumped to as high as 33 percent the day before, the highest since Sept. 29. As banks become more reluctant to offer cash to other types of institutions, the latter have to turn to the exchange for money, said Xu Hanfei, an analyst at Guotai Junan Securities Co. in Shanghai.

Bond and money markets may stabilize after Lunar New Year holidays – which start Jan. 27 and end Feb. 2 – though they’re unlikely to return to levels before the latest rout owing to yuan weakness and tighter monetary policy, said Lau. The People Bank of China’s yuan position – a gauge of capital flows – dropped the most in 10 months in November amid expectations for faster U.S. rate increases.

The onshore yuan’s surging trading volume suggests outflows are quickening, according to Harrison Hu, chief greater China economist at Royal Bank of Scotland Group Plc. The daily average value of transactions in Shanghai climbed to $34 billion in December as yesterday, the highest since at least April 2014, according to data from China Foreign Exchange Trade System. The offshore exchange rate dropped 0.15 percent yesterday to trade near a record low, while the onshore rate was little changed.

“In the new year, the new foreign-exchange purchase quota starts, so we expect yuan positions in January to drop significantly,” Liu Dongliang, an analyst at China Merchants Bank Co., wrote in a note this month. “Within the foreseeable future, the market will be pessimistic about funding conditions. It happens to be near year-end now, where money markets are tight, and after New Year’s Day it’s almost Chinese New Year.” Justina Lee, Bloomberg