A Few Thoughts on China

Three observations to share about China, regarding purchases of Japanese assets, suspension of 3-year debt auction for tomorrow and rate hike possibility.

First, Japan's MOF reported that China bought JPY262.6 bln of Japanese debt instruments in Oct. Its purchases were concentrated in the bills sector (JPY232 bln) and accounted for 23% of foreign purchases of Japanese bills in the month.

Recall that after buying a record JPY7345 bln of Japanese bills in May and more in June and July (the latter reported in September as the BOJ felt compelled to intervene in the foreign exchange market), China's intentions were broadly questioned and it turned into a large seller (more than JPY2 trillion) in Aug. China's motivations were likely similar to other investors who were caught between QEII in the US and widening spreads in peripheral Europe. Other foreign investors have been found Japanese bills a good place to park funds, for a short period.

Second, China announced it would suspend the 3-year bond auction scheduled for tomorrow. It is the first time since the reintroduction of this instrument in April that it has been suspended. The purpose of the instrument is absorb liquidity in the banking system, not to fund government spending.

This leads to directly to our third observation regarding rate hike. The suspension of the 3-year bond auction is seen as a signal that the PBOC will hike rates as early as this weekend. Given the speculation of an imminent rate hike, partly fueled by front page article earlier this week in Chinese Securities Digest, the 3-year bond auction probably would not have seen a good reception.

At the same time, China has indicated that the big monthly data dump, which includes CPI, industrial production, retail sales and fixed asset investment will be reported on Saturday local time. Previously it had indicated a Monday release. There is some risk that the PBOC hikes rates not over the weekend as many suspect, but Friday, prior to the release of the data not afterwards.

The key release from a monetary point of view is the CPI. It rose from 2.9% in June to 3.6% in September and 4.4% in Oct. News wire consensus is for a 4.7% Nov reading, there is much talk of a 5-handle. Moreover, many observers assume China's inflation is half again as high as the official data suggest. With strong money supply growth (M2 over 19% in Nov), strong bank loans, upward pressure on wages and food prices, and negative real key rates, the risk is on the upside for measured inflation.