China rates: Looser liquidity collides with increased bond supply

China rates have rallied modestly across the curve this week, with a substantial decline in money market rates and rising expectations of near-term monetary easing. We maintain a Dec-1s5s steepener position. Lower DR rates and a narrower DR007-DR001 spread could imply a faster transition from the 7d OMO rate to the overnight OMO rate, which would lower funding costs and help cap front-end swap rates. At the back end, large bond issuance scheduled in Q4 (including the extra LGB quota) and heavy positioning in (ultra) long-end bonds point to upside risks to rates. On the demand side, the sluggish onshore equity market has driven equity-bond rotations, with (ultra) long-end bonds receiving most of the inflows and outperforming the front end and belly. In strategy, we recommend paying 1y NDIRS and keeping the Dec-1s5s steepener trade with a moderate conviction level, while taking out the extra pay in Dec-5y in light of recent developments, and will reassess after the PBoC's communication a