Swaps Show Interest Rate Rises May Slow as Inflation Holds: China Credit
China will slow the pace of interest- rate increases and yuan gains as inflation levels off and the faltering expansion in the U.S. and Europe threatens export growth, derivatives contracts show.
Swap contracts based on the one-year deposit rate reflect expectations borrowing costs will rise no more than once in the coming year, after five increases in the past 10 months. Twelve- month non-deliverable forwards for the yuan ended last week at a 0.8 percent premium to the spot rate, the smallest gap since a two-year currency peg ended in June 2010.
Consumer-price gains in China held at 6.4 percent in July, the fastest rate in three years, according to the median forecast of 26 analysts surveyed by Bloomberg before data tomorrow. Should growth in food costs wane, the People’s Bank of China may be able to limit further increases in borrowing costs as traders are predicting for Brazil and Russia, where the latest data show inflation abating.
“The government doesn’t want to shock the economy with too many interest-rate increases,” said Sun Chi, a China economist with Nomura Holdings Inc. in Hong Kong who previously worked for the U.S. Treasury in Beijing. “With the external market quite weak, you don’t really want to destroy your growth momentum.”
Chinese policy makers last raised benchmark rates on July 6 by 25 basis points, or 0.25 percentage point. The one-year deposit rate is 3.5 percent and the one-year lending rate is 6.56 percent.
Stocks in China fell today, dragging the benchmark index down 20 percent from a Nov. 8 high, after Standard & Poor’s downgrade of the U.S.’s debt rating fueled concern global growth will slow. The benchmark Shanghai Composite Index slumped 3.7 percent to 2,529.88 at the 11:30 a.m. local-time break.
Inflation in the world’s fastest-growing major economy is lower than the 6.87 percent rate in Brazil, 9 percent in Russia and 9.44 percent in India. Russian weekly inflation decelerated in the week to Aug. 1 for the first time in two years. Brazilian monthly consumer prices climbed less than forecast in July.
While the Reserve Bank of India raised its repurchase rate by 50 basis points to 8 percent on July 27, the 11th increase since the start of last year, Russia last increased benchmark rates in May. Traders are pricing in the possibility Brazil’s central bank, which raised interest rates five times this year, may lower borrowing costs by the end of December.
Inflation Beats Target
Chinese Premier Wen Jiabao said at the end of June that there would be “difficulties” keeping inflation within the government’s 4 percent ceiling this year after the rate exceeded that level every month in the first half. Price increases may be kept below 5 percent after the government raised interest rates, curbed credit, imposed caps on increases in some consumer-goods prices and restricted property development and home purchases, he said.
Economists at Nomura, Capital Economics Ltd. and Credit Agricole CIB estimate inflation for the year will average more than 5 percent.
Nomura’s Sun estimates the central bank will need to raise benchmark interest rates once in the third quarter, the last move this year, as consumer-price increases “remain elevated” even as the pace of monthly gains slows. A rate increase is possible this month should July inflation come in at 6.5 percent, Citigroup Inc.’s Hong Kong-based economists Ding Shuang and Shen Minggao said in an Aug. 2 note.
“Given persistent inflation, we believe the government cannot change the tightening bias toward liquidity and credit control,” Wang Tao, UBS AG’s China economist, said in an Aug. 1 note. “However, concerns about the global recovery will limit any further tightening measures.”
Yuan-denominated government bonds are delivering a loss this quarter, with the securities losing 0.5 percent in dollar terms, according to JPMorgan Chase & Co. indexes. That compares with a loss of 0.7 percent on Russian ruble notes, and returns of 2 percent on Brazilian real bonds, and 0.8 percent for debt denominated in Indian rupees.
The yield on China’s benchmark 10-year bond was little changed at 4.05 percent last week, Chinabond data show. Five- year credit-default swaps on China’s sovereign bonds rose three basis points to 98 basis points on Aug. 5, the highest level since May 2010, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market.
The contracts insure debt against non-payment, and traders use them to speculate on credit quality. An increase suggests deteriorating perceptions of creditworthiness and a drop shows improvement.
China’s two-year interest-rate swaps that exchange the one- year official savings rate for a fixed payment have risen 11 basis points, or 0.11 percentage point, to 3.6552 percent since the PBOC last raised rates on July 6. The swaps were little changed at 3.6626 percent at 11:23 a.m. local time.
Buyers of the swaps receive the deposit rate for one year, after which the floating payment is reset for the second year at the prevailing deposit rate. The current level shows traders are betting on a rate of 3.81 percent in a year’s time.
Concern economic growth is stalling in the U.S. and Europe sparked a global rout in equities last week. Standard & Poor’s cut the U.S.’ credit rating late on Aug. 5 by one level from the highest grade of AAA to AA+ citing concern the nation doesn’t have a “credible” plan to lower its deficits.
Manufacturing in the U.S., the world’s biggest economy, grew at the weakest pace in two years in July and service industries expanded the least since February 2010. Services and manufacturing growth last month in the euro region, which is grappling with a deepening sovereign debt crisis, was the slowest in almost two years.
Expansion in overseas shipments from China, the world’s biggest exporter, may have moderated to 17 percent in July from 17.9 percent the previous month, according to the median estimate in a Bloomberg survey of 25 economists. The increase would be the smallest gain in 20 months excluding distortions caused by the timing of the Lunar New Year holiday.
Import growth probably rebounded to 22 percent from 19.3 percent the previous month, while the trade surplus widened to $27.4 billion from $22.3 billion, separate surveys showed. The data is scheduled to be published on Aug. 10.
“The bulk of Asia’s exports, including those from China, continue to be consumed by developed markets,” said Sun Mingchun, a Hong Kong-based economist with Daiwa Capital Markets Hong Kong Ltd. “As such, weakness in these markets is bound to be felt directly.”
Slowing Yuan Gains
Growth in China’s industrial output probably eased to 14.6 percent in July from 15.1 percent the previous month and retail sales growth was 17.7 percent, Bloomberg surveys show. Fixed- asset investment excluding rural households climbed 25.5 percent in the first seven months from a year earlier, based on another poll. The government will release the data tomorrow.
Moderating production and export growth and falling commodity prices may prompt the central bank to slow yuan gains as pressure from imported inflation eases and companies struggle to maintain overseas sales.
The yuan appreciated 0.43 percent versus the dollar in July, the most in three months, before retreating 0.06 percent last week to 6.4404 per dollar in Shanghai. It has strengthened 2.3 percent this year and, based on the median estimate of 31 analysts in a Bloomberg survey, will strengthen 2.2 percent to 6.30 per dollar by the end of December.
The currency gained the most since April today after the PBOC set its daily fixing 0.23 percent stronger, the biggest advance since November 2010. The yuan was trading 0.21 percent higher at 6.4267 per dollar at 11:10 a.m. in Shanghai, according to the China Foreign Exchange Trade System.
Record Reserve Requirements
The price of crude oil tumbled 12 percent last week to $84.69 a barrel by 11:56 a.m. in New York on Aug. 5. The price sank as low as $82.87, the lowest level since November. This year’s high was $114.83 on May 2.
Monetary tightening policies by China’s central bank have included nine increases in lenders’ reserve requirements since November to a record 21.5 percent for the biggest lenders. Those increases, totaling 450 basis points, have curbed lending and withdrawn 3.3 trillion yuan ($513 billion) from the banking system, according to Chang Jian, a Hong Kong-based economist with Barclays Capital.
The latest move, announced on June 14, triggered a liquidity shortage that led to a doubling of the seven-day repurchase rate to 9.04 percent on June 23, the highest level since October 2007. The repo rate, which measures interbank funding availability, dropped to 3.02 percent last week as the central bank added funds to the financial system, according to a weighted average compiled by the National Interbank Funding Center.
Banks’ new yuan loans likely fell to 550 billion yuan in July from 634 billion yuan in June, according to a separate Bloomberg survey. Expansion in M2, the broadest measure of money supply, was probably little changed at 15.8 percent. The central bank may release the data around Aug. 12.
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