Chinese FX market conservative, deploy hedging approach alternatively

The People's Bank reduced the benchmark rates, both lending and deposit rate by 25 bps to 5.1 % and 2.25 % respectively responding to the weaker than expected economic activity data which has raised concerns that the annualized gross domestic growth (GDP) target of around 7 % could be at risk.

In coming months we expect lower benchmark lending rates in addition to a more energetic quantitative efforts from the People's Bank of China, alongside a more futuristic position in its Open Market Operations, and even a more aggressive approach to the acquisition of domestic assets such as local government debt as was rumored in recent weeks.

Overall the inevitable conclusion from the general flow of economic data in the year to date is that China is in need of substantially easier financial conditions.

Derivatives Outlook:

In last quarter, CNY trading volumes segregated into four categories spot of $34 billion, outright forwards of $28 billion, FX swaps of $40 billion, and FX Options of $17 billion according to the BIS (Bank of International Settlements).

China is gradually kicking up its currency for international capital markets, however it is still far from a freely floating FX market.

Hence, we think the hedging approach through Futures and FX swaps could be an effective alternative for international participants facing FX risks by doing business in China as long as the restrictions on the free movement of capital and the managed floating approach of the Chinese national bank persists.