CNH Tracker-Yuan cross currency swap rates face downward pressure


By Michelle Chen HONG KONG, Aug 22 (Reuters) - Record high swap rates in the offshore yuan market in Hong Kong, boosted by a lack of bond issuance and a recent credit squeeze on the mainland, are set to drop as foreign issuers of dim sum bonds begin fund-raising after the summer lull. A cross currency swap (CCS), a financial instrument that allows participants to exchange both principals and interest payments denominated in two different currencies, is a favourite tool of foreign bond issuers for cheaper funding. The jump in CCS rates was largely due to a lack of offshore yuan bond issuance, which would have brought in a large amount of hedging flows and pressed down the curve, analysts said. The dim sum bond market experienced a rare barren patch with only a few small issues sold in Hong Kong in the past few months due to higher borrowing costs and worries about potential currency depreciation. A rare cash crunch in the onshore money market engineered by the People's Bank of China (PBOC) in June had also forced some players to the dollar market for funding, instead. They swapped the proceeds to yuan in the CCS market, pushing up its rates. China's short-term interest rates shot to as high as 30 percent in late June after the PBOC refused to increase money supply, widely seen as a warning to banks to crack down on risky lending practices. The CCS rates have risen so much that at current levels for 5-year and longer tenors, borrowing offshore does not offer any cost savings relative to onshore corporate funding for high grade corporations, Deutsche Bank said. "With the CNH CCS curve having steepened to the highest level over the past 12 months, we feel the balance of risks does not sustain further steepening at the long-end," said Liu Linan, a strategist at Deutsche Bank in a recent report. Three-year CNH CCS traded at 2.42 percent on Thursday, rebounding from a one-year low of 1.25 percent in May and hovering around an all-time high of 2.44 percent seen on August 7. With more fund flows set to be swapped to dollars from dim sum bond issuers in the coming weeks and less to be swapped into yuan from overseas dollar funding, the CNH CCS rate is expected to edge down from record highs. That said, a sword of Damocles hanging over the market is the prospect of a cut in stimulus by the U.S. Federal Reserve as early as in September, which has already caused jitters and capital outflows in emerging markets including China. Investors are bracing for the time when the Fed will start to slow its $85 billion in monthly asset purchases. A faster-than-expected pace of tapering bond purchases could lead to a spike in U.S. interest rates and subsequent volatility in cross currency swaps. WEEK IN REVIEW: * The Hong Kong Monetary Authority (HKMA) said on Monday it would slightly lower the throughput targets and lengthen the period to reach the targets to improve interbank yuan settlement arrangements in the real time gross settlement system (RTGS). * The Bank of East Asia said on Tuesday it had been approved as a Renminbi Qualified Foreign Institutional Investor (RQFII). The bank will use the RQFII quota for its own investment to enhance returns on its RMB funds. * Yuan deposits in Standard Chartered Bank recorded a 40 percent year-on-year increase by the end of July, said Teddy Wong, the bank's head of deposits and secured lending for Hong Kong and Greater China. Wong expected yuan deposit rates in Hong Kong to remain stable at 2.5-3 percent for the rest of the year. * Yuan deposits taken by Taiwan's domestic banking units (DBU) and overseas banking units (OBU) reached 46.6 billion yuan ($7.6 billion) and 30.3 billion yuan, respectively, by the end of July, statistics from Taiwan's central bank show. * Deutsche Bank said on Wednesday it would launch paperless cross-border payment services in China via its electronic banking platform on Sept. 1, enabling corporates to process their payments and foreign exchange transactions electronically. CHART OF THE WEEK: Long-end CNH cross currency swap rates hover around record highs: RECENT STORIES: CNH Tracker-Red tape hinders Qianhai cross-border yuan loan scheme China wants fewer curbs in free trade zones to lure foreign investment More stories about the CNH market Daily onshore yuan reports Daily China money market reports Offshore yuan rate Onshore yuan rate Offshore yuan dealt Onshore yuan on CFETS Offshore yuan bonds THOMSON REUTERS SPEED GUIDES ($1 = 6.1234 Chinese yuan) (Editing by Editing by Jacqueline Wong)

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