Crisis Gauge Flags China Cash Squeeze Followed by Growth Hitby
Interest-rate swap reaches 18-month high on liquidity concerns
Similar sovereign yield declines on economic growth pessimism
Traders in China’s interest-rate swap market are bracing for a cash shortage as the central bank cools an overheated property market. Bond investors are preparing to benefit from the slower economic growth that may result.
That’s how strategists are interpreting a blowout in the premium for the one-year swap rate over the similar-maturity sovereign bond yield to 52 basis points, the widest since July 2015. China’s version of the so-called TED spread, a gauge of financial stress that compares funding costs for banks and the government, is well below the 140 basis points reached during the trust finance crackdown of early 2014.
“This is a signal in the market that swap traders are readying for tighter liquidity as the government tries to prevent a property bubble,” said Iris Pang, senior economist for Greater China at Natixis Asia Ltd. in Hong Kong. “Further tightness may be very limited because the PBOC doesn’t want to put financial stress on the market."
The fixed cost to receive the seven-day repurchase rate for a year climbed to an 18-month high on concern the People’s Bank of China will tighten its purse strings after property prices surged 40 percent in Shanghai last month from a year earlier. Any decline in real estate activity is likely to dent growth in the world’s second-largest economy, providing a tailwind for government bonds, according to ING Groep NV and DBS Bank Ltd.
The one-year swap rate reached 2.73 percent on Friday in Shanghai, matching the highest level since April 2015, while the seven-day repo rate reached a one-month high on Thursday. The one-year sovereign yield was at 2.19 percent, heading for a third annual decline. China Securities Journal reported on its front page, citing an unidentified analyst, that finance companies need to prepare for "tight days" as monetary policy shifts to focus on deleveraging.
The prospect of slower growth and concerns over corporate defaults will spur safe-haven demand for sovereign debt, Oversea-Chinese Banking Corp. economist Tommy Xie wrote in a note on Oct. 19. DBS Bank Ltd. fixed-income strategist Eugene Leow echoed the view the next day, saying tightening could have a “detrimental effect” on the economy. Morgan Stanley said this week that home-price curbs could shave 0.6 percentage point from 2017 economic growth.
“There is a growing consensus view that macroprudential property measures will slow housing activity and economic growth,” said Tim Condon, Singapore-based head of Asian research at ING. “It has usually been a mistake to call the bottom in bond yields. In China’s case, they have further to fall.”
China’s government-swap spread reached a record high in early 2014 when regulators were wrestling with trust-product defaults. This time, stress could be linked to a crackdown on another part of China’s shadow banking system, according to Frances Cheung, head of Asian rates strategy at Societe Generale SA. The PBOC is conducting a trial monitoring of banks’ wealth-management products, according to people familiar with the matter.
The cash squeeze also reflects the flight from a weakening yuan. A net $44.7 billion worth of yuan payments left the nation last month, State Administration of Foreign Exchange data show, up from August’s outflow of $27.7 billion. The yuan slid 4.2 percent versus the dollar this year, the most among 11 Asian currencies tracked by Bloomberg. The central bank injected a net 100 billion yuan ($15 billion) on Thursday in open-market operations, bringing total additions in the past week to 760 billion yuan.
“While the PBOC is keeping liquidity accommodative, some investors may face higher costs for funding,” said David Qu, a markets economist at Australia & New Zealand Banking Group Ltd. in Shanghai. “People are expressing their views in the interest-rate swap market that the PBOC will drive up money market rates” to reduce leverage, he said.