* IRS jump implies no expectations of further rate cuts
* IRS based on short-term rates increasingly pessimistic
* Repo-based money management made cuts unnecessary -
* Economy shows signs of recovery, but risks remain -
By Lu Jianxin and Pete Sweeney
SHANGHAI, Nov 29 China's money market has
abandoned hope that Beijing will cut interest rates in the near
future, as signs of economic recovery have convinced players to
stop betting on cheaper money in the pipeline.
"Growth recovery was the last straw that broke market
expectations of another rate cut," said an IRS trader at a major
Chinese bank in Shanghai.
The People's Bank of China (PBOC) cut interest rates twice
in June and July and lowered bank's reserve requirement ratios
(RRR) three times since late 2011, freeing an estimated 1.2
trillion yuan ($192.70 billion) for new lending.
But traders and economists, with an eye on the queasy state
of global trade, predicted that the central bank would be
compelled to make further cuts, and this sentiment was clearly
reflected in China's interest rate swap (IRS) market, which
prices market's expectations for the future price of money.
Monetary easing expectations put downward pressure on
short-term and long-term IRS contracts, as the market looked
forward to a series of upcoming cuts aimed at offsetting the
effects of the slowdown in Europe.
IRS hit their lowest level since the global financial crisis
in mid-July, but rates have steadily recovered since then.
In the past two weeks rates jumped, showing that not only
have investors given up on the prospect of cuts in the near
term, they have little confidence that there will be more cuts
"If the PBOC is reluctant to cut RRR to boost economic
growth, how can it cut interest rates?" said the Shanghai IRS
IRS with a float based on the PBOC's benchmark one-year yuan
deposit rate are the most explicit indicators
of policy rate expectations.
Over the past two weeks, two-year IRS based on
this long-term rate have mostly been quoted above 2.75 percent,
compared with 2.7225 on Nov. 12, when Beijing released
better-than-expected economic data, and with 2.394 in late July.
Because China's one-year policy rate stands at 3.0 percent
at present, and because the PBOC typically cuts rates in
increments of 25 basis points, the float of the two-year IRS
suggests the market has doubts that Beijing will cut rates again
In late July, the same contracts implied that traders
expected at least two more cuts, on top of the two already
enacted, within the next 12 months.
"Deposit rate-based IRS now imply that the previously widely
expected cycle of interest rate cuts has wound down," said an
IRS trader at an Asian bank.
"This is partly an outcome of the PBOC's insistence on
keeping reverse repo rates stable since the last rate cut in
The trader was referring to the PBOC's newfound affection
for short-term reverse repos as a tool to guide rate
expectations, similar to the way the U.S. Federal Reserve
influences money rates.
The PBOC has held the official rate of its seven-day reverse
repo contract steady between 3.30-3.40 percent since early July,
when the rate was fixed at 3.80-3.95 percent, indicating that it
has no intention of allowing short-term funding costs to decline
IRS based on China's most actively traded money market rate,
the seven-day repo rate, have been gradually
trading increasingly higher than policy rate-based IRS since
late July, implying that the market is more pessimistic over
short-term funding costs.
Two-year IRS that refer to the seven-day repo rate
were quoted at 3.4 percent at midday on Thursday,
their highest level since October last year.
While IRS based on the seven-day repo rate do not directly
imply policy rate expectations, their mid-July level suggested
the market expected four PBOC rate cuts within 12 months,
GOOD FOR SAVERS, BAD FOR REAL ESTATE
China's economic managers have justified their decision to
hold off on further rate cuts by referring to fears that
inflation will return.
Officials have repeatedly noted the need to balance the
economy's need for liquidity against the risk that cheap money
will reinflate real estate asset bubbles and push up food
The benchmark one-year deposit rate had been negative
against China's CPI for more than two years until April.
"Authorities probably also don't want to discourage savers
by pushing the real interest rate into negative territory so
quickly after it has turned positive for just a few months,"
said a trader at a Chinese state-owned bank in Beijing.
Some economists still believe the PBOC should cut rates, if
for no other reason than to improve sentiment.
Domestic equities markets are still underperforming, and
while some key indicators such as exports are showing signs of
recovery, debt overhangs at local governments and state
enterprises remain a source of concern.
"I'm not convinced of the recovery story," said Chia Woon
Khien, managing director at the Royal Bank of Scotland.
"I think all sorts of things can still be cut."