Swap points have collapsed again

The USDCNY foreign exchange swap points have collapsed again, with the 1Y dropping to a low of -2485 yesterday, a decline of about 200 pips in just one week.

The interest rates in China and the U.S. have diverged again, prompting this wave of swap points to decline without resistance.

• Domestic: Under expectations of a loose policy, the market has basically priced in a 20bp OMO rate cut in the first quarter of next year, and yesterday the 1Y repo fell below 1.5%. Government bond yields are hitting new lows every day, with the 10-year government bond yield once touching the 1.7% mark, having dropped 30bp this month.

• United States: The November PPI released last week unexpectedly accelerated, and last night's December services PMI even reached a 38-month high of 58.5, reigniting inflation concerns. Currently, the market expects less than 2 rate cuts next year, with several foreign institutions stating that the Federal Reserve may only cut rates once next year or even not at all. The 10-year U.S. Treasury yield has once again reached 4.4%, rebounding 25bp from the low of 4.15% at the beginning of the month.

A Song of Ice and Fire. The negative spread between Chinese and U.S. 10-year government bonds has fallen to the deepest level in history, with the exchange rate holding up under heavy pressure at the 7.30 mark, but the swap points have already collapsed as a prelude.

This time, it’s not just the previously severely undervalued 1-year term; the middle of the curve has also started to decline significantly in recent days, especially the previously strong 6M term has also been dragged down.

Let’s take a look at how distorted the entire swap curve is through interest rate parity. From the 3M forward curves of various terms, the implied RMB interest rate for the recent 3M swap points is 1.4%, and the longer the term, the lower it is. What’s most astonishing is that the implied RMB interest rate for the 9*1Y segment is only 0.25%!!??

This means that the swap curve implies that the RMB will need to be cut by 1.4%-0.25%=115bp over the next 9 months. How is this possible? There must be some imbalance...

Through simple calculations, it can be found that the swap points for terms above 6M have seriously deviated from interest rate parity, and unreasonable pricing has begun to create allocation value. So how should we seize this opportunity? For example, clients with U.S. dollar funds can use S/B swaps + allocate short-term RMB assets to obtain higher interest income than in U.S. dollars Author of this article: Fang Yuqi, Source: Good Morning Forex, Original title: "Swap Points, Crashed Again"

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