MNI CHINA MONEY WEEK: Beijing Policymakers Increasingly Dovish

By Stuart Allsopp

     SINGAPORE (MNI) - Chinese interest rate swaps fell to new cyclical lows

Friday, with the 1-year and 2-year dropping 8bps to 2.68% and 2.76%

respectively. The longer end has fallen less, but is still approaching new lows.

Markets are increasingly warming to the idea of interest rate cuts by the PBOC.

     --EASING DOOR AJAR

     In an MNI Sources article published yesterday (see 'Real Lending Rates May

Drop As China Eases Credit'), sources close to policymakers told MNI that the

central bank may not be ready to cut benchmark rates unless soft lending doesn't

rebound and the economy stalls further. Put another way, policymakers stand

ready to ease should the ongoing trend of weakening credit growth continue.

     Considering that credit policy was eased as early as June, when big lenders

were reportedly given additional quotas, and yet total social finance (TSF)

growth has dropped to all-time lows, there is no reason to expect a rebound any

time soon.

     The ongoing plunge in equity markets appears to be the driving force behind

declining rate expectations, with the correlation between 2-year interest rate

swaps and the CSI 300 rising back towards 1. Policymakers are unlikely to want

to preside over a continued stock collapse, and will likely err on the side of

further easing even at the expense of currency weakness.

     --YUAN NOT MAIN CONCERN

     The MNI Sources article mentioned above noted that a source saying "given

rate hikes in the U.S. and pressure on yuan depreciation, cutting rates across

the board carries a lot of risks, so more targeted measures are preferred." This

suggests to us that while explicit rate cuts may not the most likely course of

action, some form of monetary easing is very much on the cards.

     The China-U.S. 2-year swap spread now sits at -13bps, having undergone a

massive 179bps fall since the start of the year, which fully explains the

collapse in the yuan. It is difficult to see the yuan's collapse ending soon

given the trends in the equity and rates markets, along with the above comments

that appear to leave the door open for further monetary easing.

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

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com

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