(Bloomberg) — China’s money markets are betting the authorities will delay their anticipated monetary easing measures in order to support the beleaguered yuan.
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The country’s five-year interest-rate swaps, a popular hedging tool, dropped below their one-year counterparts last month for the first time since September. The discount deepened to the most in almost a decade last week, according to data compiled by Bloomberg.
The inversion of the swap curve took place as traders wound back expectations for the authorities to cut interest rates or lower the reserve-requirement ratio for banks. That drove them to sell one-year swaps and buy the five-year equivalents to position for a later date for monetary easing.
Concerns over delayed easing can also be seen in the sovereign bond market, with the yield on one-year debt poised for the largest weekly increase since late 2023.
“The inversion of the interest-rate-swap curve largely reflects a delay in the much expected policy rate or RRR cut, due to China’s intention to hold the currency before US officials announces higher tariffs,” said Ju Wang, head of greater China foreign-exchange and rates strategy at BNP Paribas in Hong Kong. “It also reflects the PBOC’s contradictory policy goals of trying to limit currency losses amid monetary easing.”
The yuan has tumbled about 3.5% against the dollar in the past three months as the US currency has rallied and China’s sluggish economy has seen the nation’s bond yield discount to Treasuries widen. Concern has also grown over the impact of the higher US tariffs threatened by US President-elect Donald Trump.
The PBOC stepped up support for the yuan this month by issuing a record amount of bills in Hong Kong to soak up offshore liquidity. The central bank has also kept a relatively tight grip on the currency through its daily reference rate, which caps any movement in the yuan to a range of 2% on either side.
PBOC’s Dilemma
The dilemma facing the authorities is that they are trying to protect the yuan, while at the same time are under pressure to loosen monetary policy to bolster the flagging economy.
Inflation data published Thursday showed the consumer price index fell to 0.1% in December from a year earlier, adding to concerns over deflation and backing the case for more monetary easing. Officials have indicated their readiness to take further steps “at the right time,” though the deepening inversion in the swap markets shows traders are growing increasingly skeptical.
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“We think the IRS curve will stay inverted, reflecting the necessity to cut rates more aggressively and continued deflationary pressure,” said Becky Liu, head of China macro strategy at Standard Chartered Bank in Hong Kong, “The deep swap inversion leaves less room for trading at the current level, but yields for cash bonds have room for further declines.”
–With assistance from Iris Ouyang.
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