China's swaps market says inflation is beaten and turning point in monetary policy is near
08/30/2011 6:33 pm EST
For the first time since 2008, it’s cheaper for China’s lenders to lock in interest rates for five years than for a single year.
Swap contracts this month have in fact widened to a record gap after the People’s Bank raised reserve requirements for China’s banks effective September 5. Monetary policy is tight enough, the difference between one and five-year swap contracts say, that inflation will be headed down soon and monetary policy is n the verge of a gradual easing. (Swap contracts allow lenders such as banks to lock in interest rates for specific periods such as one or five years.)
The gap is wide enough to signal that banks believe that the People’s Bank won’t raise benchmark interest rates again this year.
Yield curves have been flattening all across the world as financial markets downgrade the risk of inflation with a slowdown in global economic growth. But China is the only major global economy—except for India—where the swaps market has actually inverted and moved to a point where the cost of locking in interest rates for five years is lower than for the next year.
At the end of 2010 I thought Brazil would be the first developing country to get inflation under control and to shift to stable or falling interest rates. China, however, now looks like the frontrunner in that contest. Both China and Brazil show falling growth rates but in Brazil economists are still cutting their projections for 2011 and 2012 growth and raising their predictions for inflation. China’s GDP grew at a 9.5% rate in the second quarter—the slowest rate since 2009--and is projected to slow to a 9.2% growth rate in the third quarter. For 2012 economists have recently lowered their projections to 8.3% to 8.9% growth.
But an increasing number of economists also now call for inflation to peak near July’s 6.5% annual rate.
If that were accurate, then next year would mark the low point for China’s growth and a high point for monetary tightness.
None of this guarantees a rally in Chinese stocks or even that China’s stocks have ended their fall. But with the Shanghai Composite Index down 15% from its April high, Chinese stocks are starting to look very, very interesting.