(Reuters) - A dramatic fall in Chinese interest rate swaps (IRS) this week suggests markets are betting a run of weak economic data will force the central bank to cut its benchmark deposit rate for the first time in over 2 years to support growth.
Though few expect such a policy response is imminent, a growing number of analysts believe the Peoples' Bank of China (PBOC) may give up its long-held resistance to cutting official interest rates - a stance traders say is driven by fear of stoking more sloppy investment, speculation and rates arbitrage.
The benchmark two-year IRS was quoted at a 13-month low of 2.79 percent on Thursday, dropping 2-plus basis points from last Friday's close.
That contract is based on the benchmark one-year deposit rate, currently fixed at 3 percent, but the market is now pricing the contract close to where rates would be if the PBOC executed a 25-basis-point cut to the one-year deposit rate.
Both the three-year IRS and five-year IRS were quoted at 2.72 percent on Thursday, implying a forecast for more than a 25-basis-point cut in the central bank's one-year deposit rate. "The IRS movement reflected across-the-board drops in money market funding costs after the PBOC cut the official yield," said an IRS trader at a Chinese commercial bank in Shanghai.
"After their latest decline, long-term IRS contracts do indeed now imply at least one official interest rate cut over the course of three years or longer," he said, adding that most traders he speaks with do not expect the cut to come soon.
Indeed, the IRS curve based on the seven-day repo rate has fallen and flattened in the last three months, although given abnormal liquidity conditions it is a less reliable indicator of market expectations for official policy cuts and more suggestive of general expectations for easier money going forward.
Economists have grown increasingly bearish about third quarter growth figures, with a Reuters poll now predicting GDP growth will come in at 7.2 percent, down from 7.5 percent in the previous quarter, on the back of a series of lacklustre economic indicators in September.
However, there is a rigorous debate over how and whether the PBOC might address the risk of slowing growth. Global markets turbulence this week on worries over the health of the world economy has also given expression to fears of a deeper downturn in the world's second-biggest economy.
Some economists believe the central bank will need to make a significant adjustment by cutting reserve requirements across the board for banks, flooding markets with trillions of fresh yuan. Others argue regulators will instead move to reduce interest rates, encouraging more credit into the real economy, propping up a worrying decline in investment rates by Chinese companies.
"We believe that the likelihood of universal RRR or rate cuts is still small as the government likely wishes to avoid a rebound in speculation in the property markets and a rapid accumulation of debt," Ting Lu, China Economist at Bank of America Merrill Lynch in Hong Kong, wrote in a research note this week.
MONEY RATES TAKE THE LEAD
The IRS fall comes after the central bank lowered the yield for its bond repurchase agreement auctions on Tuesday for the third time this year.
This has also been perceived as part of an effort to lower short term funding costs in a targeted fashion, following precision cuts to RRR at selected smaller banks and other short-term liquidity operations that cashed up major banks in September.
"Bank funding is tight due to high WMP (wealth management product) rates and low deposit growth. Funding costs remain high as a result, despite lower interbank rates" wrote Oliver Barron of NSBO in a research note, pointing to historically low loan demand.
"We consider an interest rate cut is likely in Q4, while continued tight liquidity also makes an RRR cut in Q1 15 likely." The PBOC on Tuesday lowered the yield of the 14-day bond repurchase agreements during open market operations to 3.4 percent, down from 3.5 percent in its previous operations last Thursday.
Traders said that move helped push the weighted average of the benchmark seven-day repo rate down 8 basis points to 2.98 percent by late morning from the close of last Friday.
The average of shortest one-day repo rate fell 8 basis point to 2.47 percent, while the 14-day repo rate slipped 1 basis point to 3.31 percent. However, market rates have been generally low in recent months and traders said liquidity has been adequate; it's willingness to lend that is proving the problem.
China's lending figures have weakened as shadow banking activity has been squeezed, highlighting underlying weakness in real business demand that is difficult to ameliorate through monetary tools alone.
reuters.com
Though few expect such a policy response is imminent, a growing number of analysts believe the Peoples' Bank of China (PBOC) may give up its long-held resistance to cutting official interest rates - a stance traders say is driven by fear of stoking more sloppy investment, speculation and rates arbitrage.
The benchmark two-year IRS was quoted at a 13-month low of 2.79 percent on Thursday, dropping 2-plus basis points from last Friday's close.
That contract is based on the benchmark one-year deposit rate, currently fixed at 3 percent, but the market is now pricing the contract close to where rates would be if the PBOC executed a 25-basis-point cut to the one-year deposit rate.
Both the three-year IRS and five-year IRS were quoted at 2.72 percent on Thursday, implying a forecast for more than a 25-basis-point cut in the central bank's one-year deposit rate. "The IRS movement reflected across-the-board drops in money market funding costs after the PBOC cut the official yield," said an IRS trader at a Chinese commercial bank in Shanghai.
"After their latest decline, long-term IRS contracts do indeed now imply at least one official interest rate cut over the course of three years or longer," he said, adding that most traders he speaks with do not expect the cut to come soon.
Indeed, the IRS curve based on the seven-day repo rate has fallen and flattened in the last three months, although given abnormal liquidity conditions it is a less reliable indicator of market expectations for official policy cuts and more suggestive of general expectations for easier money going forward.
Economists have grown increasingly bearish about third quarter growth figures, with a Reuters poll now predicting GDP growth will come in at 7.2 percent, down from 7.5 percent in the previous quarter, on the back of a series of lacklustre economic indicators in September.
However, there is a rigorous debate over how and whether the PBOC might address the risk of slowing growth. Global markets turbulence this week on worries over the health of the world economy has also given expression to fears of a deeper downturn in the world's second-biggest economy.
Some economists believe the central bank will need to make a significant adjustment by cutting reserve requirements across the board for banks, flooding markets with trillions of fresh yuan. Others argue regulators will instead move to reduce interest rates, encouraging more credit into the real economy, propping up a worrying decline in investment rates by Chinese companies.
"We believe that the likelihood of universal RRR or rate cuts is still small as the government likely wishes to avoid a rebound in speculation in the property markets and a rapid accumulation of debt," Ting Lu, China Economist at Bank of America Merrill Lynch in Hong Kong, wrote in a research note this week.
MONEY RATES TAKE THE LEAD
The IRS fall comes after the central bank lowered the yield for its bond repurchase agreement auctions on Tuesday for the third time this year.
This has also been perceived as part of an effort to lower short term funding costs in a targeted fashion, following precision cuts to RRR at selected smaller banks and other short-term liquidity operations that cashed up major banks in September.
"Bank funding is tight due to high WMP (wealth management product) rates and low deposit growth. Funding costs remain high as a result, despite lower interbank rates" wrote Oliver Barron of NSBO in a research note, pointing to historically low loan demand.
"We consider an interest rate cut is likely in Q4, while continued tight liquidity also makes an RRR cut in Q1 15 likely." The PBOC on Tuesday lowered the yield of the 14-day bond repurchase agreements during open market operations to 3.4 percent, down from 3.5 percent in its previous operations last Thursday.
Traders said that move helped push the weighted average of the benchmark seven-day repo rate down 8 basis points to 2.98 percent by late morning from the close of last Friday.
The average of shortest one-day repo rate fell 8 basis point to 2.47 percent, while the 14-day repo rate slipped 1 basis point to 3.31 percent. However, market rates have been generally low in recent months and traders said liquidity has been adequate; it's willingness to lend that is proving the problem.
China's lending figures have weakened as shadow banking activity has been squeezed, highlighting underlying weakness in real business demand that is difficult to ameliorate through monetary tools alone.
reuters.com
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