Supply-demand dynamics expected to remain favorable in CNH CCS market

The PBoC took a major decision this morning to improve the pricing mechanism of the daily fixing rate. With the bank now moving towards a currency management mechanism to reflect where spot CNY is trading, the risks are much higher for further CNY depreciation, with expectations of this outcome likely to drive FX forward points higher, says Barclays. 

The supply-demand dynamics is expected to remain favorable for higher rates in the CNH CCS market. Indeed, an expectations of a weaker RMB should lead to increased demand for hedging of RMB-denominated assets or cash flows.

Moreover, this is likely to reduce global investors' appetite for 'Dim Sum' bonds, which comes at a time when maturities of these bonds are rather light (CNH38.2bn of maturities in Q2 vs an estimated CNH15.6bn in Q3). 

"Therefore, a likely reduction in Dim Sum bond issuance and hedging flows, which supported the market through Q2 15, should mean little resistance to a move higher in CNH CCS. Moreover, we think that market positioning is skewed towards being short USDCNH, hence, a likely unwinding of which may further impact the market beyond today's knee-jerk reaction", according to Barclays.

The market has the potential to move significantly higher, once it fully digests this large change in China's FX policy framework.

"Therefore, investors are suggested paying 1y CNH CCS at an indicative level of 3.50% (or where it settles down), which strengthens their existing view of a bear flattening trend in the CNH CCS market. So far, market reaction to the news has been rather benign. The 1y CNH CCS shot up to 3.55% on the announcement, but then moved back to around 3.40-3.50% after the initial bounce", states Barclays.