In the middle of the year, liquidity is an unavoidable topic. The historical pattern of liquidity fluctuations, coupled with the reality of low bank overstocking and stricter regulation, led the market to be quite cautious about liquidity expectations for June. However, the easing of short-term funds in May exceeded expectations, indicating that there are still positive factors at this stage. Analysts point out that in June, facing uncertain factors such as possible adjustments in Federal Reserve policies, semi annual assessments of domestic banks, and adjustments to financial institutions' balance sheets, liquidity is bound to fluctuate and become tight. However, considering the early response of institutions and the timely maintenance of stability by the central bank, the sustained abnormal liquidity tightness will be a rare event.

'Unable to get out' and 'unable to merge'

Previously seeking to borrow overnight, now seeking to get overnight, "the fund trader's words expressed the contrast in the fund situation around May.

The market was originally not optimistic about the liquidity situation in May, as it faced both a large number of MLF maturities and disturbances in the settlement and payment of corporate income tax from the previous year. But in fact, except for one or two trading days at the beginning of the month, the overall market liquidity in May was relatively loose, especially in the second half of the month when short-term liquidity remained abundant, with some areas showing oversupply.

The short-term funding interest rate significantly decreased in May. Taking the interbank pledged repo rate as an example, the weighted average interest rate for overnight repo (R001) has been decreasing by 2.54% from 3.11% at the end of April; The weighted average interest rate for 7-day repurchase (R007) rose by 4.36% at the end of April and has now fallen by 2.98%.

Compared with the same period last year, although the current market funding situation is not particularly loose, the actual feeling brought by short-term liquidity easing is very strong in the context of tight balance becoming the norm. The trader mentioned above said, "Previously, the funding situation would tighten every late month, but since May, it has remained calm and has become even more relaxed recently. This is a scenario that was never imagined before

However, while the short-term funding rate is declining, the long-term funding rate remains high.

The divergence between long-term and short-term money market interest rates has led to a significant widening of the term spread of money market interest rates, indicating to some extent that the difficulty of financing medium and long-term funds has relatively increased, and the market remains cautious about expectations of medium and long-term liquidity. The recent cross season and longer-term fund withdrawals are still ongoing, "said the trader.

On one hand, short-term funds cannot be withdrawn, and on the other hand, medium and long-term funds cannot be raised. In May, the market's funding situation presented a complex situation of both tightness and looseness.

Multi factor disturbance

After entering June, whether the situation of abundant short-term funds can continue and whether the expectation of tight medium and long-term funds will become a reality are both concerns of the market.

The market is concerned about mid year liquidity. From a historical perspective, at the end of the season, due to the assessment of various regulatory indicators by the central bank's MPA and the China Banking Regulatory Commission, the funding situation often tightens, and mid year fluctuations are more likely to occur. Meanwhile, the excess reserves of banks in the middle of the year often decrease significantly compared to the beginning of the year. The first quarter monetary policy report of the People's Bank of China revealed that as of the end of March, the excess reserve ratio of financial institutions decreased by 1.3%, which is the second lowest value since this statistical data was available. Although the overstock rate may have rebounded since May, it may still be at a relatively low level. In the absence of sufficient overall supply, seasonal disturbances such as MPA assessments have increased, coupled with strict financial regulation and deleveraging. Financial institutions' demand for liquidity has risen, which can easily lead to tight supply and demand relationships and marginal tightening.

Analysts point out that the motivation for financial institutions to increase leverage is to take advantage of interest rate spreads, mainly including term spreads and credit spreads. The former is achieved by linking short-term liabilities to long-term assets, while the latter is manifested as a tendency towards downgrading asset ratings. In the past round of leverage increase, interbank liabilities have expanded significantly, but such liabilities have shorter maturities and there is a significant need for rolling renewals. With the tightening of banking supervision, interbank and wealth management businesses face greater pressure to contract, leading to increased instability and management difficulties on the liability side. On the asset side, short-term adjustments are extremely difficult and often only naturally mature. Therefore, in the process of deleveraging, there is a risk of a shortfall in assets and liabilities, and leverage will first passively rise, resulting in an increase in demand for liabilities and funds over a certain period of time. The increasing competition among banks for traditional deposits and the continuous rise in interbank debt interest rates such as certificates of deposit are manifestations of financial institutions' efforts to compete for debt in the context of deleveraging.

In addition, under deleveraging pressure, financial institutions' liquidity expectations are relatively cautious, which can also lead to a precautionary increase in the demand for capital reserves, further exacerbating the contradiction between supply and demand of funds.

Moreover, the Federal Reserve may raise interest rates again in June, which cannot be ignored in terms of its impact on foreign exchange liquidity and RMB liquidity.

Taking into account the above factors, the uncertainty of liquidity in the banking system remains significant at the mid year point. The recent continuous rise in medium - and long-term money market interest rates reflects to some extent the market's cautious expectations for cross seasonal liquidity.

Monetary policy 'subjective' changes

Although the pressure still exists, the positive changes in the funding situation since May should also be taken seriously.

Overall, there are multiple reasons for the improvement in liquidity in May. Firstly, the exchange rate of the Chinese yuan against the US dollar has improved to some extent, promoting the improvement of foreign exchange reserves. The China Foreign Exchange Trading Center recently stated that it is considering introducing countercyclical factors into the model for quoting the central parity rate of the Chinese yuan against the US dollar. This move will help correct depreciation expectations and is expected to further improve foreign exchange holdings, thereby improving the liquidity of the banking system.

Secondly, deleveraging has reduced the demand for financing. For some banks, under regulatory pressure, if they sell interbank assets or do not renew interbank assets after maturity, but their liabilities have not yet matured, there will be a surplus of funds that may not be available for long-term investment, but can be used for short-term lending and repurchase transactions before the liabilities mature. In addition, various banks are responding to the pressure of interbank debt maturity, and are working hard to increase reserve levels and reduce long-term investments, which may result in excess short-term positions in their hands for the time being. For non bank financial institutions, they also prepare liquidity to cope with bank redemptions, and these funds may also become short-term funding supplies in the market before redemption. The abundant supply of short-term funds is not unrelated to this.

Thirdly, the willingness of the central bank to provide liquidity has increased. It is difficult to say that monetary policy has turned, but for market institutions, a turning point in monetary policy has already appeared in terms of 'perception'

The first quarter monetary policy report of the People's Bank of China stated that in the coming period, the central bank's reverse repurchase operations will mainly be based on 7-day terms. When there are temporary or seasonal disturbances, the central bank will also choose to carry out reverse repurchase operations of other maturity varieties. MLF operations will primarily focus on 1-year maturities, with additional maturities as necessary to better meet the medium to long-term liquidity needs of financial institutions.

The risk of semi annual liquidity fluctuations cannot be ignored, but the market has fully recognized this. Based on past experience, the more cautious the market expectations are, the more comprehensive the response will be. Coupled with timely stability maintenance operations by the central bank, the performance of funds may not be as tight as expected. Overall, the possibility of extreme abnormal fluctuations in liquidity in June is very low.