FxWirePro: Mid-tenor CNY swap rates likely to agonize amid bearish bond market

There has been a total of CNY310bn of reverse repos matured in thee recent past, with no MLF due. The PBoC is likely to provide liquidity when the market needs it but will maintain a neutral-to-mild tightening stance – its balance sheet is shrinking again.

From a fund-flow perspective, Pressure from capital flight has eased markedly as the Chinese economy firms up and the yuan stabilizes against the US dollar.

China's forex reserves rose for the third month in a row in April, central bank data showed Sunday.

The viewpoint supporting an optimistic outlook on Renminbi is that the Chinese corporate sector’s net FX balance position has already improved significantly over the past two years. Indeed, from the liability side, the stock of other Investment liabilities (containing trade credit, loans, currency and deposits/others) in China’s NIIP is now 1.3-sigma below the 2004-2015 avg, the stock of Other Investment Assets is 2.3 sigmas above the same 12y average.

Meanwhile, on the asset side, exactly the opposite phenomenon has played out in recent years. Chinese private sector (read corporate) has accumulated 10.3ppt of GDP of USDs over the past two years with 1ppt of that in 4Q16, which seems to imply some mean reversion may well be due.

Reduced capital outflow pressure, on the other hand, removes one potential tightening factor. On balance, front-end rates should be better anchored now after the extended period of the uptrend.

Meanwhile, the bond market is likely to stay bearish, suffering from continued financial deleveraging. More than half of WMPs, for example, invest in bond and money market instruments.

Mid-tenor swap rates will suffer more, as investors use them to express/hedge against this bearishness. The IRS and NDIRS curves are as a result likely to steepen.