This week, China’s central bank added 1.3 trillion yuan to the banking system. This is the largest short-term liquidity boost since January. On Wednesday, the injections peaked at 444.6 billion yuan. By Friday, this amount had decreased to 102.8 billion yuan. Repo rates dropped for three days in a row, showing that market stress is easing.

Liquidity and Market Conditions

The increase in liquidity comes at a time when funding conditions are tight. Repo rates have risen above the policy rate due to low consumer confidence and weak export expectations. Analysts think that liquidity support might drop after the tax deadline on July 15. This move aims to ease the funding pressure caused by significant tax payments and a spike in government bond issuances. We see the central bank’s liquidity injection as a temporary solution for stability, not a major policy change. It’s a response to seasonal demands, which means the calm in the market may be short-lived. We expect low volatility in the near term. However, the overall economic outlook remains weak. The official manufacturing PMI for June unexpectedly fell to 49.5, indicating a contraction. Combined with producer prices being in deflation for over 20 months, this suggests that any rise in asset prices will be uncertain. This sets the stage for increased volatility once the current support is removed.

Expected Market Movements

As repo rates fall, we anticipate that short-term interest rate futures will show this easing, but this opportunity is closing quickly. Traders should be ready for a reversal after the July 15 tax deadline, as the central bank has indicated it wants to reduce these actions. This suggests a chance to prepare for higher short-term rates later in the month. Historically, after major injections like the one in January, Chinese equities only experienced temporary rallies before fundamental issues emerged again. Therefore, we believe that short-dated call options on major indices like the CSI 300 could yield tactical gains this week. A wise approach would be to also consider buying put options that expire in late July or August to protect against the likely return of negative sentiment. Create your live VT Markets account and start trading now.

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