06/17/2015
China / Rates
Several factors have combined to nudge up Chinese yuan market rates in the past few weeks.
Several factors have combined to nudge up Chinese yuan market rates over the past few weeks. Firstly, incremental easing has probably fanned reflation expectations, even as price pressures are currently muted. This has lifted longer-term China government bond yields, steepening the curve in the process.
Moreover, the authorities authorised another 1 trillion yuan debt swap last week (taking the total approved to 2 trillion yuan). Increasing competition for government bonds from these upcoming municipal bond issues should continue to put upward pressure on longer-term government bond yields.
Secondly, liquidity conditions appear to be tightening and that has been affecting shorter-term yuan rates. The seven-day repo rate (which serves as the floating leg fixing of yuan swaps) has risen to 2.24%, up by 33 basis points since the low in mid-May. Term premium, which was negative through to early April, also picked up with the spread of the one-year yuan swap rate over the seven-day repo rate widening to 26 basis points.
While impending initial public offerings have locked up funds, we think that upward pressure on short-term yuan rates should prove limited. In any case, the still high reserve requirement ratio (18.5%) offers ample leeway to keep a lid on any excessive increase in short-term yuan rates.
Meanwhile, five-year yuan swap rates and five-year offshore yuan cross currency swap (CCS) rates have been tracking closely since convergence took place in late 2014/early 2015. In fact, five-year offshore yuan CCS rates have been trading above the onshore five-year yuan swap rate since late January as onshore liquidity conditions improve on the back of monetary easing by the People’s Bank of China. This marks a trend reversal from 2011-2014 when offshore funding tended to be much lower than onshore funding.
With renminbi appreciation no longer a one-way bet, the accumulation of offshore yuan deposits in Hong Kong has slowed while offshore yuan forward points are high. These conditions, which are likely to persist for the short term have kept offshore yuan rates relatively high compared to onshore yuan rates. If onshore interest rates continue creeping higher, spill-over into offshore rates would be inevitable.
