China swaps traders are switching to bets on higher market interest rates as the economy improves, and away from anticipating further monetary stimulus.
(Bloomberg) — China swaps traders are switching to bets on higher market interest rates as the economy improves, and away from anticipating further monetary stimulus.
Yuan five-year non-deliverable interest-rate swaps climbed to almost 3% this week, the highest since December 2019 — before the global outbreak of the pandemic — and up from as low as 2.38% in October. Swaps are derivatives used to exchange future interest payments and provide a guide for where markets anticipate rates will be when the contracts mature.
Optimism over the economic recovery has been growing. A gauge of manufacturing published Wednesday showed the biggest improvement in more than a decade, while central-bank data released last month showed banks extended a record amount of new loans in January. The People’s Bank of China in its quarterly monetary-policy report published last week also painted a more positive picture of the economy.
“Swap rates efficiently reflect expectations of tightening liquidity going forward, as the market has been dialing back hopes for PBOC easing given it has refrained from cutting rates or lowering the reserve ratio since November,” said Zhaopeng Xing, a senior strategist at Australia & New Zealand Banking Group in Shanghai.
The impact of the rebounding economy has also been showing up in the money market. Injections of liquidity from the PBOC have failed to satisfy the surging demand for cash, pushing borrowing costs higher. The seven-day interbank repurchase rate has largely been above 2% this year, the level of the PBOC’s comparable reverse repo rate, indicating excess demand for funds.
Guiding Rates
The PBOC in last week’s monetary-policy report showed more tolerance for rising rates, saying only it would “guide market rates to move around policy rates,” a statement that didn’t appear in its previous two quarterly publications. For some market watchers, that suggests the central bank is preparing to move toward a more neutral policy stance, one that would narrow its divergence with the Federal Reserve that has been weighing on capital flows.
The changes in the PBOC’s tone are early hints of a tilt toward a neutral policy, Citigroup Global Markets economists Xiangrong Yu and Xinyu Ji wrote in a research note this week. “The PBOC could switch to a ‘wait-and-see’ mode quickly as growth is back on track.”
While analysts don’t expect the PBOC to hike its key interest rates just yet, switching to a neutral stance may mean it keeps its policy benchmark and the reserve requirement ratio for banks unchanged, and ensures credit and money supply grows at the same pace as nominal gross domestic product.
More Easing
Some analysts argue swap rates have risen too high, especially as government bonds yields have remained little changed despite the improving economic data.
“The end of pandemic-era monetary policy doesn’t necessarily signify the end of China’s easing bias,” said Tommy Xie, head of Greater China research at Oversea-Chinese Banking Corp. in Singapore. There’s still a possibility China will lower rates given uncertainty about how quickly consumption will bounce back and whether or not households will reduce their savings and spend more, he said.
Cutting the reserve-requirement ratio remains an effective way to provide long-term liquidity, PBOC Governor Yi Gang said at a media briefing Friday. China’s real interest rates are at relatively appropriate level, he said.
The five-year interest-rate swap was little changed at 2.99% following Yi’s comments, while the yuan gained 0.2%. Traders are now looking for potential clues about future policy from the annual gathering of the National People’s Congress that begins Sunday, where Yi’s successor is likely to be named.
–With assistance from Ran Li, Nasreen Seria and Yujing Liu.
(Updates to add PBOC comments in 11th paragraph and market rates in 12th)
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