China Bonds Rally as PBOC Easing Sends Interest-Rate Swaps Lower

  • Yuan erases loss amid signs it will win IMF reserve status
  • Stimulus "adds fuel to the risk-on environment," ING says

China’s bonds rallied and interest-rate swaps fell the most in two months after the central bank cut borrowing costs for the sixth time in a year and eased lenders’ reserve requirements.

The yield on sovereign bonds due July 2025 fell four basis points to 3.04 percent as of 4:53 p.m. in Shanghai, the lowest for a benchmark 10-year note since January 2009. The cost of one-year interest-rate swaps, the fixed payment to receive the floating seven-day repurchase rate, sank 10 basis points to 2.29 percent. The yuan declined and the Shanghai Composite Index of shares rose to a two-month high.

"The rate cuts have injected funds into the markets and pushed the rates down," said Chen Ji, a Shanghai-based researcher specializing in monetary policy at Bank of Communications Co. "From now on, the People’s Bank of China will likely roll out more targeted easing measures to stimulate the economy."

The latest round of easing, which was announced late Friday, came after a report showing economic growth was the slowest in six years in the third quarter and followed a surprise devaluation of the yuan in August. Goldman Sachs Group Inc. estimated the easing will release 600 billion yuan to 700 billion yuan ($94 billion to $110 billion) into the financial system, helping keep borrowing costs down at a time of record capital outflows from the world’s second-largest economy. The U.S. bank predicts China will lower reserve requirements again this year while preventing the yuan from weakening.

IMF Review

The currency declined 0.05 percent to close at 6.3529 a dollar in Shanghai. The International Monetary Fund has given Chinese officials strong signals in meetings that the yuan is likely to win inclusion in a November review of its Special Drawing Rights basket of reserve currencies, said three people who asked not to be identified because the talks were private. Chinese officials are so confident of winning approval that they have begun preparing statements to celebrate the decision, according to two of the people.

"The decline in the yuan has been mild as the market expects that the currency will be kept stable before the IMF’s review and as people are growing more optimistic that it’ll be included in the SDR," said Kenix Lai, a foreign-exchange analyst at Bank of East Asia Ltd. in Hong Kong. "The yuan will likely weaken more after the review as economic fundamentals remain weak."

The PBOC’s latest easing will keep the Chinese currency under downward pressure and drive money-market rates lower, but won’t have much of an impact on longer-term bond yields, Elias Haddad, a Sydney-based currency strategist at Commonwealth Bank of Australia, wrote in a note. The most likely effect of the easing will be increased expectations for China’s currency to depreciate, said Peter Kinsella, head of emerging-market economics and foreign-exchange research at Commerzbank AG in London.

Rates Cut

The PBOC reduced its one-year lending rate to 4.35 percent from 4.6 percent effective Saturday, while the one-year deposit rate was cut to 1.5 percent from 1.75 percent. Reserve requirements for all banks were lowered by 50 basis points, with an extra 50 basis point reduction for some. The PBOC also scrapped a deposit rate ceiling that limited what banks could pay savers, saying the move was made possible by a decline in market interest rates.

The seven-day repo rate, a gauge of interbank funding availability, declined three basis points to 2.35 percent, according to a weighted average from the National Interbank Funding Center. It earlier dropped to 2.29 percent, the lowest this month. The Shanghai Composite Index increased 0.5 percent to end at 3,429.58, the highest close since Aug. 21.

Capital Outflows

The central bank’s August devaluation roiled global markets and spurred an exodus of cash from China. Capital outflows climbed to $194.3 billion in September, exceeding the previous high of $141.7 billion in August, according to a Bloomberg estimate that also takes into account decisions by exporters and direct investment recipients to hold funds in dollars.

Demand for emerging-market assets was recovering prior to China’s latest rate cut. The MSCI Emerging Markets Index of shares has rebounded 9.7 percent in October, after a third-quarter slide of 19 percent that marked its steepest drop in four years.

“China’s stimulus adds fuel to the risk-on environment,” said Viraj Patel, a London-based currency strategist at ING Groep NV. “The move sends two signals - while it is indeed a positive for risk appetite, it also confirms the fact that the Chinese economy remains in a fragile state.”

— With assistance by Tian Chen, and Kartik Goyal

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