Yields of China domestic rates fell moderately after Leave vote

　　The UK voted to leave the European Union last week. The global FX, bond and stockmarkets witnessed significant movements, while the reaction of China's domestic bondmarket was much milder. The yield of the 10-year Chinese government bond (CGB)moved down by around 5bp last Friday, 24 June, while the five-year repo nondeliverableinterest rate swaps (NDIRS) rate dropped around 10bp to its lowest andclosed at 2.62% that day, down 6bp from Thursday's close.

　　Positive factors for lower rates still exist

　　We believe the reasons why we thought there might be room for rate yields to adjustdownward still stand, which include: 1) less pressure from economic fundamentals; and2) eased liquidity conditions after the end of June (see Less pressure from fundamentalsfor more details). The People's Bank of China (PBC) has increased the amount of moneyinjected through the open-market seven-day reverse repo operation and net injectedRmb175bn and Rmb340bn in the past two weeks, and we think market concern overliquidity conditions has been relieved to some extent. In addition, following the UK's EUreferendum result, UBS’s US economists think that increased global risks mean aSeptember rate hike becomes less likely and they only maintains their call for aDecember hike. Our China economists also think that the PBC may cut the reserverequirement ratio (RRR), as a gesture to ease domestic liquidity and part of coordinatedglobal monetary easing (see It's 'Leave' - Brexit Delays Fed Tightening and It's 'Leave' -What It Means for APAC for more details). The PBC published a statement last Fridaysaying that it has been closely monitoring the developments of UK's referendum andhas put in place contingency plans. It also said that it will further enhance policycommunication and coordination with relevant central banks. We think the policy toneregarding the CNY exchange rate remains that, as stated in PBC Governor ZhouXiaochuan's interview in early February this year, the government has been enhancingits policy communication and is determined to maintain relative exchange rate stability(see Voices from PBC during CNY holiday for more details). Therefore, we believe thegovernment may take measures to keep the currency from depreciating too much ifmarket volatility remains high in the following weeks. We also think the currencydepreciation risk may not be a major obstacle for CNY rate yields to benefit from likelypolicy easing expectations caused by the UK referendum result.

　　Hold the five-year repo NDIRS receiver's position

　　We previously recommended investors to take a five-year repo NDIRS receiver's positionat around 2.75% level, targeting 2.60%. The five-year repo NDIRS once traded around2.59% last Friday and closed near 2.62% that day. We recommend investors to holdthe five-year receiver's position, expand our target to 2.45% and trim the stop at2.75%. We think the current level of the interbank seven-day repo rate can still provideprotection for this position through positive carry.