China Rates Strategy:Yields may fluctuate in September

Rates market

    First, we think the upside pressure on the yield curve from economic fundamentals islimited. Second, though the PBC still intends to keep liquidity stable and money marketrates low, we think money market rates are unlikely to break below their previous lowlevels, and the PBC is very cautious about sending further easing signals. Therefore,policy easing expectations may be subdued again. Third, the supply-demandrelationship is unlikely to improve in September (it may turn better for policy financialbonds in Q4). And fourth, Fed Chair Janet Yellen recently mentioned that the economiccase for a rate hike has strengthened in recent months, and the expectations of a ratehike have risen in overseas markets. We think the uncertainty over a September hikemay make investors cautious ahead of the September Fed meeting. In general, we thinkthat compared with the beginning of Q3, the momentum for a further yield decline haslost steam. With short-term money market rates unchanged, the room for a furthersqueeze in term spreads is very limited. However, the weak economic fundamentalsalso limit room for upward adjustment. We therefore expect the rates curve tofluctuate around the current level for some time in September, as will the spreadbetween policy financial bonds and central government bonds.