China yields continue slide on policy shift hopes

By Andrew Torchia

SHANGHAI, Feb 2 (Reuters) - Bill and bond yields above three months continued to slide on Saturday on investor hopes the central bank would soon ease its tight monetary policy, to help small firms and banks overcome funding problems and prepare for a possible U.S. recession.

Trade was light in a special session before week-long Lunar New Year holidays, which will start on Wednesday, and traders said some prices might not be fully representative of the market.

But they said the bond market rally had probably built up enough momentum to continue through the end of this month.

"Yields won't continue to drop so fast, but the bond market may stay bullish for the medium term," said a trader at a mid-sized Chinese bank.

The indicative seven-year government bond yield <CN7YTFIX=R> in the secondary market dropped to a four-month low of 4.0438 percent bid from Friday's 4.1326 percent -- its biggest daily fall in half a year, according to Reuters Reference Rates.

The yield has slid 30 basis points in the past nine trading days, and many traders think its initial target is 3.95 percent, the yield at Friday's bullish auction of seven-year government bonds.

Other government bond yields fell between 2 and 6 bps, with the largest falls in the more liquid front half of the curve. This caused the two- to ten-year spread <CN2YTFIX=R> <CN10YTFIX=R> to widen back to 49 bps from 45 bps.

The spread hit a low of 42 bps this week, its lowest level since at least 2003, in a flattening trend caused partly by the view that while the central bank would largely halt interest rate hikes because of falling U.S. rates, it would continue tightening money market liquidity through quantitative steps.