In recent days, concerns about liquidity in the financial markets have intensified dramaticallyMany institutions are feeling the pressure, caught in a frenzy as they scramble to secure funds.

With the Lunar New Year approaching, there’s a palpable sense of urgency for the central bank to interveneIf they do not take actions to inject liquidity into the system soon, the potential for a cash crunch before and after the holiday could adversely impact not only the financial sector but also the stock market.

Let’s delve into the stock market situation first.

Today, the stock market opened to rather unfortunate signals, particularly with a notable drop in shares of Cambrian Intelligence, which plummeted 14.65%. Following a peak at an all-time high of 777.77, the stock has seen a decline of 23.63%, breaking through key moving average lines, including the 5-day, 10-day, and 30-day averages.

The predicament facing Cambrian can be attributed to the excessive prior alignment of institutional investors, which has led to inflated valuations

Even if some speculate about the prospect of lucrative orders coming its way, current valuations appear unjustified and exceedingly high, particularly since such orders have yet to materializeThe looming Lunar New Year and the impending season for annual reports have caused some analysts to cash out, leading to stronger selling pressure on shares of Cambrian.

Now, on to the matters of cash shortage in the system.

On Wednesday, January 15, non-banking institutions faced difficulties obtaining funds to balance positionsReports indicated that interbank borrowing costs for overnight loans soared as high as 16% after 4 PM.

This morning (January 16), the situation had not improved, with overnight borrowing costs remaining high at above 10% for many institutions.

Later in the afternoon, conditions tightened further, with the cost of borrowing overnight for some non-banking entities skyrocketing to 18%.

At this point, the overall overnight interest rates in the market were roughly 1.84%.

It should be noted that while the current tightening of funds is primarily affecting certain non-banking institutions, it has yet to spread across the broader market

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However, this is an important reminder to remain vigilant, as the risk of a cash crunch is ever-present.

Why has the liquidity situation suddenly tightened?

Firstly, the tax period is causing increased demand for funding, leading to heightened competition for available capital in the marketHistorical data suggests that during tax collection times, the central bank typically provides added liquidity; however, this time around, they adopted a tightening stance instead.

Secondly, there are escalating expectations for capital demands

The initial wave of loans from banks at the year’s onset and the anticipated concentration of treasury bond issuances has yet to take off, contributing to pressure on market liquidity.

Third, there’s also the phenomenon of some non-banking institutions overly betting on declining liquidity, engaging in short-term borrowing with long-term investments, expecting to profit from any discrepancies in interest ratesThis strategy backfired as funding costs rose sharply, causing severe constraints.

This leads to situations where these institutions might find themselves borrowing at 18% to invest in securities yielding only 1.6%, resulting in untenable positions.

Compounding the issue, these organizations are required to close their positions within a stipulated time duration, forcing them to secure sufficient funding at all costs.

Consequently, there's an alarming surge in overnight borrowing costs as a result of these dynamics.

This coincides with a positive feedback loop of liquidity issues in the market.

In fact, the tightening of the financial market has been ongoing for several days, triggered by rising rates that provoke panic, driving rates even higher, creating a vicious cycle that can easily spiral out of control.

It is crucial to break this cycle promptly; otherwise, a cash shortage may occur as we transition into the new year.

The fourth point worth noting is the significant maturity of MLF (Medium-Term Lending Facility) funds, alongside the central bank's net liquidity withdrawal.

Throughout January, the central bank has been actively retracting liquidity from the market

For instance, even as of January 15, the central bank continued to reduce funds.

On that day, the central bank injected 959.5 billion yuan into the market; however, MLF repayments totaled 995 billion yuan, resulting in a net outflow of 36.6 billion yuan.

Moreover, the central bank has paused its treasury bond purchases, which is a crucial method for injecting liquidity into the market.

Starting from January 10, the central bank announced a suspension of treasury bond purchases on the open market effective from January 2025.

Buying treasury bonds allows the central bank to inject liquidity directly and create base currency

This action is essentially similar to operations such as MLF injections or reserve requirement ratio cuts.

By halting bond purchases, the central bank effectively ceases liquidity injections into the market.

Trends regarding liquidity since last year indicate that the central bank's MLF volume has been shrinking significantlyFor the span between August and December, the MLF's decline reached 2.181 trillion yuan, albeit accompanied by liquidity injections through various means, including the use of reverse repos.

In brief, the central bank is injecting significantly less liquidity than before.

Why has the central bank stopped injecting liquidity?

As analyzed previously, the central bank faces a dilemma

On one side, soaring demand for bonds has driven interest rates down, which creates a rush among investorsShould the central bank intervene, the rates might fall further.

Additionally, with the depreciation of the renminbi already significant, lowering interest rates further could lead to an even steeper decline in its value.

On the other hand, there is a pressing need to infuse liquidity into the market to maintain a relaxed monetary policy that supports the real economy.

Ultimately, weighing all considerations, the central bank has chosen to pause liquidity injections to stabilize the bond market and currency exchange rates.

It raises an important question: the market has been waiting for easing measures, such as RRR cuts or interest rate reductions

However, what is this so-called "moderate easing"?

Looking ahead, the key will be the stance the central bank adopts before the Lunar New Year.

This serves as a warning for the bond market, indicating that there are already signs of a cash crunch, which could leave many financial institutions in precarious positions.

Should the bond market reverse trend, this could spell disaster for those heavily betting on declining interest rates.

The looming question is: will the central bank pivot swiftly enough to avert a potential liquidity crisis in the coming weeks?