China's Rate Swaps Rise to One-Year High as Stimulus Bets Fade

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China’s interest-rate swaps rose to a 12-month high on bets a pick-up in economic growth and signs of speculative trading in commodities and property will prevent the central bank from adding to stimulus.

The cost of one-year swaps, the fixed payment to receive the floating seven-day repurchase rate, increased six basis points to 2.62 percent at 4:30 p.m. in Shanghai, the highest since April 2015. The People’s Bank of China will keep benchmark interest rates on hold until the fourth quarter, according to economists in an April 15-20 survey.

Recent Chinese indicators from a purchasers’ manufacturing index to credit growth have beaten estimates, while surging trading in commodities futures prompted mainland exchanges to boost fees or issue warnings to investors. Demand for hedges have also received a boost from concern about a new tax. There is speculation that trading in the bonds of policy banks will be subject to a higher levy from next month, when a 6 percent value-added tax replaces a business tax of 5.5 percent.

“We’re probably experiencing the inflection point in PBOC’s liquidity management,” said Chen Long, an analyst at Bank of Dongguan Co. in Guangdong province. “The central bank may not keep interbank liquidity as loose as before to prevent a leverage-fueled rally in financial markets now that the economy is picking up. Besides, the VAT adoption is adding to the cost of rate swaps.”

Property Boost

New credit topped $1 trillion in the first quarter, helping gross domestic product to expand 6.7 percent -- still the slowest pace in seven years. Much of that money flowed into the real estate market, spurring concerns of a bubble.

The five-year swap rate gained five basis points to a one-year high of 2.99 percent, data compiled by Bloomberg show.

The yield on China Development Bank bonds due April 2026 advanced six basis points to 3.50 percent, according to National Interbank Funding Center prices. The yield on a benchmark 10-year CDB security rose nine basis points last week, the most since May, compared with a one basis point increase in sovereign notes, ChinaBond data show.

As banks don’t have access to bond futures, they can only turn to the swaps to hedge the risks of rising interest rates, said Chen.

There are signs the central bank is increasingly using short-term lending tools to add liquidity instead of more permanent measures, such as cutting reserve-ratio requirements for financial companies.

The PBOC auctioned 180 billion yuan ($27.6 billion) of seven-day reverse-repurchase agreements on Monday, more than the 30 billion yuan of such contracts matured. The central bank injected a net 680 billion yuan using the contracts last week, close to a record 690 billion yuan added before the Lunar New Year holidays, data compiled by Bloomberg show.

— With assistance by Helen Sun

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