Investors scale back China rate cut bets

Investors are reducing bets on immediate rate cuts in China as the derivatives market indicates a shift in expectations that policymakers will hold off on easing policy amid a weakening yuan.

Yuan interest rate swaps (IRS) have been inverted for almost four weeks, with short-term rates rising as rate cut expectations diminish. Domestic investors use IRS to hedge and express rate views.

On Tuesday, the difference between five-year IRS and one-year swaps reached its lowest level in almost ten years, at minus-9 basis points.

“The inversion signals the markets are dialling back expectations of People’s Bank of China (PBC) interest rate cuts and in the reserve requirement ratios (RRRs),” analysts at Commerzbank said in a note.

Amid concerns about yuan stability, widening China-US bond yield differentials and uncertainties about US trade tariffs have worsened yuan weakness against the dollar, limiting PBC’s monetary easing options.

Investors are anticipating rate cuts, pushing bond yields lower, following China’s commitment to a loose monetary policy in 2025, the first easing stance in over a decade.

Their attempts to boost a sluggish economy are being challenged by the depreciation of the Chinese yuan due to increasing yield differentials between the US and China, as well as escalating trade tensions with the US and other countries.

Attribution: Reuters

Subediting: M. S. Salama