What a difference three weeks makes. On January 18, heading into the Lunar New Year holidays, we reported that the PBOC had injected a record 1.04 trillion yuan into the liquidity-starved banking system in an attempt to avoid a liquidity crunch as telegraphed just days prior by dramatic surge in short-term repo rates.

Since then, however, between the end of the holidays, and the stated Chinese intention to tighten the monetary system, things have changed drastically.

First of all, last Friday, China announced an unexpected tightening of policy when it raised rates on 7, 14 and 28-day reverse repos by 10bps to 2.35%, 2.50% and 2.65% respectively. That was first increase in the 28-day contracts since 2015 and since 2013 for the other two tenors. As this was the first working day following the New Year holiday in China, it was a decent "statement of intent" by the PBoC.

At the same time, as we explained on Sunday, in a parallel tightening episode, the PBOC also increased Standing Lending Facility rates on overnight/7-day/1-month tenors by 35bp/10bp/10bp (to 3.10%/3.35%/3.7%), sending Chinese government bond futures sliding as fears rose that China is actually serious about tightening this time.

Then on Thursday morning, an article in China's Securities Journal said that China may keep tightening monetary policy this year amid pressure from yuan rate stabilization, financial de-leveraging, curbs on real estate and faster inflation. In other words, China may have reached the phase where it admits it has a problem, and is ready to do something about it. What was notable is that the article hinted that while even more could be done, the economic basis and inflation situation don’t yet support China entering interest rate hike cycle.

Translation: if inflation picks up more from here, the PBOC will use the shotgun approach and hike rates. For now however, the piece concluded that the central bank is focusing more on price tools, which means "an increase in open market rates may be considered guidance."

And sure enough, 20 days after the PBOC had injected a record CNY1+ trillion in liquidity, it is now draining it just as fast, and as the PBOC just reported, the Central Bank did not conduct any Reverse Repo open market operations for the fifth consecutive trading day "in order to maintain a stable level of liquidity in the interbank market", the PBOC said in a statement on its website.

With CNY150 billion of reverse repos maturing today, the PBOC's lack of action had the effect of draining CNY150 billion from the market today.

The PBOC also added that "while the central bank has started to gradually drain liquidity from the interbank market after the end of the Chinese New Year holiday, liquidity is still at an adequate level" repeating the explanation it used in the past three days.

According to Market News, the market sees the lack of open market operations as a clear signal of tighter monetary policy. Furthermore, the consecutive stops of OMOs show PBOC's bias for a prudent tilted to neutral monetary policy in a bid to prevent risks and reduce leverage ratio, said Ming Ming, chief analyst with CITIC Securities in a research note.

In total, the PBOC has drained a total of CNY715 billion in liquidity so far this week, primarily as a result of maturing reverse repos which the central bank refuses to roll over. A total of CNY80 billion in reverse repos will mature later this week and the market will be watching the PBOC's response closely. Should it perceive that the PBOC has withdrawn too much liquidity, another liquidity tantrum is inevitable.