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The front end CNH rates remain low amid ample liquidity. The switch to the averaging method in required reserve calculation for onshore RMB deposits placed by offshore banks may still be having an impact, in discouraging the parking of RMB funds onshore.
Other factors for the low CNH rates possibly include issuer swap flows upon dim sum bond issuances; higher southbound quota usage under the Shanghai-Hong Kong Stock Connect, averaging 13% in the past month versus around 6% in the prior period.
Increasing USD funding costs in onshore China encouraging entities to source funds via other channels. It is not easy to time when these flows are digested and when FX can exert a bigger impact on CNH rates.
By the end of 2016, we expect USD/CNY to be testing 7.0 due to a mix of cyclical USD strength as well as domestic factors. FX intervention cannot continue indefinitely. Widening GDP growth, inflation, and interest rate differentials also argue for a higher USD/CNY.
Well, by the end of 2016, we expect the benchmark 1-year lending rate to be at 4.10% and the RRR (for major banks) to be at 15.5%.
There had been an extended period where CNH CCS/implied rates were mainly driven by liquidity rather than FX, in 2011/12, for example.
