CHINA MONEY WEEK: Upside Risks For China Market Rates

--China Equities Need To Join In The Broader Rally

By Stuart Allsopp

     SINGAPORE (MNI) - China interest rate swaps are showing strong upside

potential after rising in response to the news of planned trade talks between

the U.S. and China later this month. The entire swap curve shifted higher on the

news and yields appear to be tracing out an inverse head-and-shoulders

formation, with the 10-year pushing above resistance Friday to trade at 3.36%.

     The bearish case for rates is strengthened by the ongoing rise in the

spread between 10-year swaps and 10-year government bond yields, which has

reached -31bps, its highest level in 18 months. It seems as though the bond

market is increasingly pricing in the prospect of increased issuance amid the

growing likelihood of fiscal expansion.

     The China-U.S. 2-year yield spread actually bottomed out on August 7 but

received another boost yesterday from the trade news, rising to four-week highs

of 30bps. The yuan has benefitted from the recovery in yield spreads, with

USDCNH coming back from Wednesday's highs, now threatening to break the uptrend.

A close below the 21-DMA, currently at 6.8425, would make a strong case for a

continued rally in the yuan.

     The one key factor that warrants caution, however, is the failure of the

equity market to hold onto the gains seen following the positive trade news.

Mainland equity benchmarks in particular have performed poorly, with the CSI 300

failing to show any meaningful recovery. A recovery in equities is likely needed

for the rise in swap rates and the yuan to continue.

     --FURTHER RISKS

     Another risk comes if trade talks fail to yield positive results. In an

exclusive interview (see 'MNI EXCLUSIVE: China-U.S. Trade Talks Unlikely To

Produce Deal') trade experts advising the Chinese government told MNI that the

talks are expected to end with little in the way of solid results.

     "Despite plans to negotiate, I personally think the chance of a big success

or breakthrough is low," Mei Xinyu, a researcher at the Chinese Academy of

International Trade and Economic Cooperation under China's Ministry of Commerce,

told MNI on Thursday. The researcher also added that "There will not be much

sincerity in Washington's efforts to reach a deal. That will come only after it

feels obvious pain."

     Nonetheless, the upside risk to rates is rising, and even if a trade deal

is not reached, the likelihood is that the Chinese authorities will resort to

fiscal expansion -- which will likely put upside pressure on bond yields anyway.

--MNI Singapore Bureau; +65 8233 2326; email: Asia-Editor@marketnews.com

[TOPICS: MT$$$$,MX$$$$]