SHANGHAI: China's interest rate swaps bounced higher on Tuesday, as the central bank's continued use of reverse repos weakened market expectations for a near-term cut in banks' required reserve ratio (RRR).
"Expectations of an RRR cut over the weekend didn't pan out, so there was some disappointment and a rebound," said a trader
at a city commercial bank in Shanghai.
Better-than-expected US employment data released Friday has also contributed to the rise in interest rate swaps (IRS) this week, as yuan IRS rose in sympathy with dollar rates.
China's central bank often announces RRR cuts on Fridays or during the weekend, and many traders expected such an announcement last week, after the benchmark seven-day bond repurchase rate peaked at 3.4862 percent on Aug 2, up from 3.1389 on July 30.
Expectations for an RRR cut were further bolstered by the People's Bank of China's net drain of 86 billion yuan from the banking system last week, the largest net drain since January.
Traders believed the drain may have been a preemptive move to smooth out the impact of the large liquidity injection caused by an RRR cut. A cut of 50 basis points would inject more than 400 billion yuan into the banking system.
But the announcement never came, and traders now say that a cut may not occur until the second half of August.
Benchmark five-year IRS were bid at 2.82 percent at midday, up from 2.78 at Monday's close and 2.68 percent at the end of last week.
One-year IRS were bid at 2.74 percent at midday, up from 2.65 percent at Monday's close and 2.56 percent at last week's close.
Rising bond yields are also influencing IRS, traders said. Heavy bond selling on Monday pushed up bond yields, which generally move in sync with IRS, as banks may use them to hedge potential losses on their bond portfolios.
"If bond prices fall severely, IRS will rise together with yields," said a trader at an Asian bank in Shanghai.
In the money market, rates were mixed. The seven-day repo rate was at 3.2535 percent at midday, down from 3.4076 at Monday's close. But the overnight rate rose 5.21 bps to 2.5446 percent. The fourteen-day rate was flat at 3.4119 percent.
The central bank looks poised for a moderate net injection of funds into the money market this week, which could further postpone the need for an RRR cut.
The PBOC injected 50 billion yuan into the money markets on Tuesday via seven-day reverse repos, compared to a 56 billion yuan drain scheduled this week due to maturing instruments.
That means even a small additional injection via reverse repos on Thursday will result in a net injection this week.
Traders still expect a cut in RRR this month, but generally won't hazard a guess on timing.
"The central bank will be looking to see if inflation rebounded in July," said the Asian bank trader, referring to July data due out this week.
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