Tao Chuan: The New Meaning and Significance of the Central Bank's "Temporary Repurchase"

Today, the People's Bank of China took another important step in the market-oriented reform of interest rates. Following the announcement of bond issuance last week, the central bank shifted its focus to the short end by announcing that it will conduct temporary repurchase operations with an overnight tenor in the future. It is worth noting that the "anchor" of the new tool remains the 7-day reverse repurchase rate. On one hand, Governor Yi Gang's mention of "using a short-term operation rate of the central bank as the main policy rate" is about to be revealed. On the other hand, the upper limit of the new tool (1.8% + 50bp = 2.3%) seems to "echo" the market 10-year government bond yield announced by the central bank last week (2.2-2.3%), indicating a deeper meaning behind the normalization of the central bank's interest rate curve.

The new temporary repurchase tool is not a "rate cut," but it may be more important than a "rate cut," mainly reflecting the central bank's "greater certainty" about short-term rates. As the central bank will be able to absorb/withdraw funds from the market using the temporary repurchase rate in the future, thereby constraining interbank funding costs, the newly set price range of "lower limit -20bp, upper limit +50bp" may replace the previous "lower limit excess reserve rate, upper limit SLF," taking the first step towards narrowing the interest rate corridor.

In terms of strategy, this time the central bank is similar to the Federal Reserve. One of the core elements of the Federal Reserve's interest rate corridor is the use of overnight reverse repurchase agreements, ensuring that institutions do not borrow funds below the target lower limit level, a strategy similar to the central bank's temporary repurchase tool this time. However, unlike the United States where repurchase agreements are mainly initiated by market participants, the People's Bank of China "operates as needed," giving the central bank more initiative. From the perspective of the People's Bank of China, interbank market rates in China are often affected by factors such as taxes, holidays, and month-end, leading to relatively large fluctuations. Therefore, narrowing the interest rate corridor to stabilize fund price fluctuations can be seen as a "necessary path" for reform.

At the same time, the overnight market rate may have a "new benchmark." Overnight repurchase agreements are actually the main financing method among financial institutions, historically accounting for 8 to 9 percent of the total repurchase volume. However, there has been a lack of clear "policy rate" guidance in the past, leading to volatile fluctuations. In comparison with overseas practices, the Federal Reserve's federal funds rate and the European Central Bank's main refinancing rate have clearly defined overnight rate "benchmarks," resulting in significantly lower fluctuations in market rates.

Behind the "greater certainty" is the central bank's clue of "from short to long" regulation. The "anchor" of the new temporary repurchase tool remains the 7-day reverse repurchase rate, essentially confirming the central bank's approach of using the 7-day OMO rate as the main policy rate, while the previously commonly used MLF may gradually diminish its "policy rate" color At the same time, the upper limit of the new tool (1.8% + 50bp = 2.3%) happens to be around the market's 10-year government bond yield (2.2%-2.3%) when the central bank announced borrowing last week. We believe that the purpose of the central bank "maintaining a normal upward-sloping yield curve" is self-evident.

For the market, we believe that the impact of the new tool on fund prices is controllable, while short-term bonds may have adjustment risks. Looking at the recent trends in the money market, both DR001 and R001 have fluctuated within the new price range, and it is difficult to touch the upper and lower bounds in the short term; but considering that short-term bond yields have long been lower than the OMO interest rate operation, the 1.6% lower bound of the new tool may have a significant impact on short-term bonds.

Risk Warning: Monetary policy exceeds expectations; overseas interest rate cuts progress exceeds expectations; domestic economic fundamentals exceed expectations