Something odd is going on in China. On one hand, the PBOC has been soaking up excess liquidity from the market like a drunken sailor, and after not conducting reverse repos for 10 consecutive days, it has reduced the excess liquidity level by 510bn yuan in the latest week as existing open market operations matured, and roughly half that in the week prior.

On the surface, this would suggest a sharp tightening in monetary conditions, and yet precisely the opposite is taking place: over the past week, instead of rising short-term rates – the traditional indicator of tighter conditions in China – yields on Chinese short-dated instruments have tumbled. Putting the move in context, 1Y yields have plunged nearly 20bps in the first week of 2018, the biggest weekly slide since June 2015.

In parallel, on Thursday the 7-Day repurchase rate slid to the lowest since April.

While some have provided theoretical explanations, nobody really knows what is going on. In fact, some such as Citi have put on the tinfoil hat and speculate that the PBOC is covertly adding tons of liquidity on the short-end of the curve, to wit:

It looks like the PBoC has been adding quite a lot of liquidity in the shorter end of the curve in recent days -with a variety of interbank rates softer, and the 1y CGB yield notably lower by 21bps YTD whereas 5s and 10s yields have stayed broadly flat. 

Assuming that Citi is correct, it would explain many things, not least of all the stunning surge higher in Chinese, global and even US stocks. This is how Citi puts it:

Against that background, it is no surprise that equity markets have been so well supported and the SHPROP has exploded upward.

 

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