China’s money markets indicate a potential delay in anticipated monetary easing measures as authorities prioritize supporting the struggling yuan. This strategic decision reflects a complex balancing act between bolstering economic growth and maintaining currency stability.
A key indicator of this shift is the inversion of China’s interest rate swap curve. Five-year interest-rate swaps, a common hedging instrument, fell below their one-year counterparts in December 2024 for the first time since September. This discount widened significantly in the following weeks, reaching a near-decade high, according to Bloomberg data. This inversion signals traders are adjusting their expectations for interest rate cuts or reductions in bank reserve requirements, pushing back anticipated easing timelines. Consequently, traders have sold one-year swaps and purchased five-year equivalents, positioning for monetary easing further in the future.
This delay in easing expectations is also evident in the sovereign bond market. The yield on one-year debt experienced its most substantial weekly increase since late 2023, further reinforcing the narrative of postponed monetary stimulus. Experts attribute this shift to China’s efforts to stabilize the yuan before potential US tariff increases.
“The inverted interest-rate-swap curve primarily reflects a postponement of the widely expected policy rate or RRR cut,” explains Ju Wang, head of greater China foreign-exchange and rates strategy at BNP Paribas in Hong Kong. “This delay stems from China’s commitment to supporting the yuan ahead of potential US tariff announcements. It also highlights the PBOC’s conflicting policy objectives of mitigating currency depreciation while pursuing monetary easing.”
The yuan has depreciated roughly 3.5% against the dollar over the past three months, driven by a strengthening US dollar, China’s slowing economic growth, and a widening bond yield differential between China and the US. Concerns surrounding potential US tariff hikes under the incoming US President-elect Donald Trump have further exacerbated the pressure on the yuan.
In response, the People’s Bank of China (PBOC) has intensified its efforts to support the yuan. These measures include issuing a record amount of bills in Hong Kong to absorb offshore liquidity and maintaining a tight grip on the currency through its daily reference rate, limiting fluctuations to a 2% range. Additionally, the PBOC suspended government bond purchases, a move interpreted as supporting the currency. Australia & New Zealand Banking Group Ltd. suggests this halt aligns with their assessment that expectations of loose monetary policy may not materialize due to the downward pressure on the yuan.
A PBOC-affiliated newspaper quoted an economist cautioning against overinterpreting the extent of monetary easing and advising against aggressive market bets. Consequently, China’s one-year yield has risen over 15 basis points this week to 1.17%, while the 10-year yield has rebounded from a record low. This delicate balancing act underscores the PBOC’s challenge in simultaneously safeguarding the yuan and stimulating a slowing economy.
The PBOC faces the dilemma of defending the yuan while facing pressure to implement monetary easing to revitalize the economy. December’s inflation data, revealing a drop in the consumer price index to 0.1% year-on-year, further intensifies concerns about deflation and strengthens the argument for monetary stimulus. While officials have signaled their willingness to take further steps “at the right time,” the deepening inversion in the swap markets indicates growing skepticism among traders.
“We anticipate the IRS curve will remain inverted, reflecting the need for more aggressive rate cuts and persistent deflationary pressure,” states Becky Liu, head of China macro strategy at Standard Chartered Bank in Hong Kong. “The significant swap inversion limits trading opportunities at the current level, but cash bond yields have room for further decline.” This complex interplay between currency stability and economic stimulus will continue to shape China’s monetary policy decisions in the coming months.
