8 Economists' Investment Tips
Xu Xiaoqing: “Ten-Year Interest Rate Mentality” -- Repurchase Interest Rates for the Three Major Money Market Interest Rates
Summary of this issue
Typical interest rates in the money market, when measured by transaction volume, clearly have more say in terms of repurchase interest rates than lending rates
The central bank issues bonds for a different purpose than any other entity.
Although the seven-day repurchase rate acts as a benchmark interest rate, it won't tell you as clearly as the Federal Reserve.
What's in this issue
The 3 main money market interest rates
There are three main money market interest rates: the one-day repurchase rate, the seven-day repurchase rate, and the three-month Shibor.
Shibor is actually a lending rate. What is the difference between the repurchase rate and the loan rate? The lending interest rate is calculated based on the daily quoted interest rates of 18 major banks in China. In other words, if a bank wants to invest in capital, it is willing to borrow according to this interest rate, so the lending rate is based on the bank's credit. The vast majority of the benchmark interest rates we see abroad are lending rates, such as LIBOR, which everyone is most familiar with.
The following picture is a comparison chart of the repurchase and loan volume between banks in the market. The red column represents the repurchase volume, and the yellow color also represents the repurchase volume, but it is a buyout type of repurchase, and the gray color represents the volume of repurchase transactions. You can see that the volume of loan transactions has been rising over the past few years, but it is much smaller than the volume of buyback transactions. In other words, if we want to choose a representative interest rate in the money market, measured by transaction volume, it is clear that the repurchase interest rate has more say than the lending rate. So in China, what people are more concerned about is not the lending rate, but the repurchase rate.
What is the repurchase rate? The so-called buyback means that you actually need to use some high-grade treasury bonds or financial bonds as collateral, and then borrow money. Why is it called a repurchase? Because a real repurchase abroad actually involves two transactions. First, you have to sell the bond to the other party, then get the money. Waiting until the money is paid back is equivalent to buying the bond back, so it's called a repurchase. But in China, most repurchases we call pledged repurchases. What does that mean? That is, there is no actual so-called conversion of bond ownership. If there is a conversion, we call it a buyout repurchase. In most cases, the ownership of a bond remains the same; it is simply used as collateral to obtain capital and then repay the debt. In this process, a capital price is generated, which is the repurchase interest rate. The reason why buyback transactions are very active in China is because in the early days, China actually did not have a credit system in the true sense of the word. Everyone did not trust each other, so they were unwilling to obtain funds through lending, and were more willing to obtain funds by using bonds as collateral. This has caused China's repurchase rate transactions to be extremely active.
The chart also shows the share of the transaction amount of repurchases over different periods in the market. We can see that the one-day repurchase transaction amount currently accounts for close to 80% of the total transaction amount. However, the one-day repurchase interest rate fluctuates too much, and the seven-day interest rate will be more stable. Therefore, between one day and seven days, we tend to think that the seven-day repurchase rate is more suitable as China's benchmark interest rate.
Benchmark interest rate for exiting the stage - central bank
In the early days, another type of market interest rate had the possibility of becoming China's benchmark interest rate, the interest rate for issuing central bank notes.
The following chart shows the interest rate for issuing one-year central bank notes and interest rates on deposits. The deposit interest rate is our traditional benchmark interest rate in the past, and the government still insists that the one-year deposit interest rate is China's benchmark interest rate. But since it's not a market-based interest rate, people don't pay much attention.
As we can see from the chart, the interest rate for issuing bank notes and the fluctuation in deposit interest rates are basically the same in direction, but the fluctuation is even greater. Moreover, from 2006 to 2007, that is, in the past interest rate hike cycle, interest rates issued on central bank notes will show signs of rising earlier than the benchmark interest rate. Therefore, when we were engaged in bond research in the early days, we also preferred to judge the central bank's policy intentions by observing the interest rate at which central bank notes were issued.
However, the central bank issues central bank notes, which is a historical phenomenon. The chart also shows the stock of central bank notes. You will find that the highest number of central bank notes issued was probably from 2008 to 2009, and then declined all the way down. Up to now, it has actually withdrawn from the historical stage, which means that the central bank note is only a phased product.
Why should the central bank issue bonds? The central bank issues bonds for a different purpose than any other entity.
All other entities issue bonds for only one purpose, which is to raise capital. Government bonds and corporate bonds are all issued to obtain capital to meet the investment needs of entities. Why is the central bank issuing bonds? Does the central bank need to issue bonds? The money was printed by the central bank. Is it short of money? The central bank is not short of money, so why should it issue bonds? The central bank issues bonds to recover liquidity.
We can understand all the money as the central bank's debt. The central bank also has a balance sheet. All currency issued is the central bank's debt, so the central bank's notes are also its liabilities. When the amount of notes the central bank increases, it means that its debt is also increasing. If it wants to keep its total debt unchanged, it must mean that the amount of money issued will decrease accordingly.
Therefore, central bank notes are actually a tool for recovering liquidity, just as we saw in the open market that central banks regulate liquidity through repurchases. But this is only a phased product. It is a recouping method adopted after China joined the WTO due to the influx of foreign exchange accounts brought about by a sharp increase in trade volume.
Deposit interest rate vs repurchase rate
Well, in the true sense of the word, the interest rate that actually has the status of a benchmark interest rate that everyone is more concerned about is the one-day repurchase interest rate we just talked about. In the early days, repurchase interest rates also basically fluctuated around deposit interest rates, which were generally consistent with the trend of deposit interest rates. However, since the last interest rate cut in 2015, deposit interest rates have not changed, yet the repurchase rate has fluctuated in the past two to three years.
In the past two years, we know that monetary policy has actually adopted a tightening approach, so repurchase interest rates have risen sharply. If you only focus on one-year deposit interest rates, you'd think that monetary policy has never been tightened, and there have been no real interest rate hikes; but if you look at repurchase interest rates, you'll find that the central bank has actually taken measures to raise interest rates, adding at least 100 points from the low in 2016 to the high in 2018.
Everyone should also be familiar with the money shortage that occurred in 2013, when the repurchase rate soared to 7%. However, throughout 2013, there was no change in the official benchmark interest rate, but in fact, monetary policy was drastically tightened, which showed a sharp rise in repurchase interest rates.
Therefore, in China, we attach great importance to changes in repurchase interest rates. In fact, it plays exactly the same role as the US federal funds rate, except that it is seven days, while the federal funds rate is one day.
Interest rate corridor with seven-day repurchase interest rates
The following chart shows the average seven-day repurchase interest rate in China. The central bank never talks about how much it thinks the seven-day repurchase rate should be, which means that although it plays the role of the benchmark interest rate, we don't know what point the central bank wants the benchmark interest rate to reach. It won't tell you as clearly as the Federal Reserve, but it will give you other interest rates, which is equivalent to setting the upper and lower limits of the seven-day repurchase interest rate. So how is this upper and lower limit determined?
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