The recent correction in China’s inverted interest-rate swap curve indicates growing confidence that stimulus efforts may revive the economy. The five-year swap rate has surpassed the one-year rate, ending a previous deflation-driven discount which reached 15 basis points in February.
Growing Optimism About Economic Recovery
Experts suggest this move reflects optimism about supply-side reforms potentially lifting China out of deflation within the next 12 to 24 months. Although near-term rate cuts are anticipated, the long-term outlook seems less bleak.
Additionally, the steepening of the swap curve might continue, suggesting an early stage shift in market expectations for China’s economic recovery. Earlier, the People’s Bank of China set the USD/CNY central rate at 7.1460, compared to an estimate of 7.1635.
The correction in China’s interest-rate swap curve is a clear signal for us to act. We believe this is an opportunity to position for a steeper curve by considering trades that benefit from long-term rates rising faster than short-term ones. This environment suggests the market is finally starting to price in a future economic recovery.
This optimism is backed by recent data showing the Caixin Manufacturing PMI rose to 51.7 in May, the fastest expansion in nearly two years and well above expectations. This hard data gives credence to the idea that massive government support for the property sector and other stimulus measures are beginning to work. We should therefore see the current market sentiment as more than just speculation.
Focusing On Long Term Opportunities
Following the view from Liu, we should look past any potential near-term rate cuts and focus on the longer-term outlook. This means we are exploring call options on Chinese equity indices, as the CSI 300 has already rallied more than 15% from its lows earlier this year. The shifting sentiment suggests there is more room for equities to run.
Zhaopeng’s point about a potentially persistent curve steepening, combined with the central bank’s strong guidance on the currency, reinforces our view. The consistently stronger-than-expected Yuan fixing indicates an official desire for stability, which supports our economy-positive stance. Consequently, we are also evaluating strategies to go long on the Yuan against the dollar.