Asia Rates: CNY IRS pricing is optimistic
CNY Rates - While onshore markets are closed this week, USDCNH has moved lower by almost 500pips. With depreciation pressures appearing to ease, currency considerations could be less of a hurdle in terms of policymakers considering another round of rate cuts. Our economists are expecting further cuts to the 1Y LPR in 4Q, which implies likely further cuts to the 1Y MLF as well. We think cuts to OMO and Bank RRR could also be possible.
Compared to other swap markets, CNY IRS has tended to display an asymmetry in pricing - Being more keen to price for normalization and more resistant to price for rate cuts. And we see it in the current IRS curve, where there are no rate cut expectations being priced in and the 7D repo fixing is priced to converge with OMO rate within the next 3-6 months.
We think current IRS pricing is rather optimistic on normalization. Barring significant policy changes and stimulus, China's growth recovery is likely to be gradual and credit demand could stay soft for some time. Therefore, there are certainly some prospects of rate cuts that shouldn't be discounted (likelihood of rate hikes is negligible). Liquidity conditions are also likely to stay ample and thus, convergence of 7D repo fixing with OMO is likely to take longer than the priced 3-6 months. In our view, receive 1Y and 2Y IRS looks like good risk-reward.
INR Rates - Post the market holiday on Wednesday, OIS rates and GSec yields opened 10-15bps higher on Thursday open. Higher US rates were likely the primary cause, more so than GBI-EM index news (where FAR bonds were not included). Unwinding of index inclusion positioning would argue for bond-swap spread tightening, but there were no noticeable signs of tightening yesterday. Liquidity conditions have eased in recent days, with larger liquidity placed at RBI's SDF and ON call money/Mibor rates falling back into the rate corridor.
IDR Rates - Over the last 2 days, 10Y IndoGB-UST yield differential has compressed 25bps. Since early August, that differential has compressed a massive 100bps. At around 340bps now, yield differential is close to the tightest in almost 2 decades. Naturally, there are investor questions whether IndoGBs are primed to see a fairly large sell off (our positioning tracker show fund managers holding a small underweight). While 10Y yield differentials, as a proxy for risk premium in IndoGBs, have in the past been a decent predictor of IndoGB returns, we think it will be less important to monitor going forward. Compared to pre-COVID, foreign ownership of IndoGB has fallen from ~40% to the current ~15% and Indonesia's CA/BOP profile has seen structural improvements. Both factors, we think, argue for a lower beta/passthrough from US rates and local drivers are seeing a rise in significance. 10Y IndoGB-UST yield differentials could test 300bps before year-end, especially if 10Y UST breaks above 4%.
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