Longer-term Chinese government bond yields fell sharply on Monday, with the 15-year yield sinking 9 basis points, its biggest drop since early February, because of signs of slowing economic growth. But interest rate swaps did not fall because money market liquidity, to which yuan IRS are very sensitive, is unlikely to loosen further for now, traders said.
Offshore IRS were roughly flat while onshore IRS rose. China's official purchasing managers' index was 48.4 in August, unchanged from July and representing the second straight month below the boom-bust line of 50, the China Federation of Logistics and Purchasing said.
A separate PMI published by brokerage CLSA fell to 49.2 in August from 53.3 in July, the first time since November 2005 that it dropped below 50 to indicate a manufacturing contraction. CLSA attributed the drop mainly to disruptions caused by last month's Beijing Olympics, but traders said the data fed into other signs that the economy was slowing considerably, which could prompt easing of monetary policy later this year.
The Shanghai Composite Index was down more than 3 percent on Monday afternoon after the end of the first-half corporate earnings reporting season confirmed that growth in companies' profits was slowing greatly.
"The bond market thinks slowing economic growth may be a big problem for a large nation like China, which is concerned about employment issues," said an analyst at a mid-sized Chinese bank in Guangzhou. The indicative 15-year government bond yield dropped to a two-month low of 4.6255 percent bid on Monday from 4.7136 percent on Friday, according to Reuters Reference Rates.
Other medium- and long-term bond yields fell by around 5 bps, while short-term bond yields were only about 1 bp lower. Most traders still do not see a significant chance of an official interest rate cut this year, but many are discussing the possibility of a cut in bank reserve ratios late in 2008 if economic growth and the stock market continue to sag.
Signs that inflation has peaked are also expected to support the three-week-old rally in bonds, traders said. Shenyin & Wanguo Securities predicted in a research note on Monday that August consumer price inflation, to be announced on Thursday next week, would come in between 5.3 and 5.4 percent, down from a 10-month low of 6.3 percent in July. The brokerage also forecast August producer price inflation would ease to 9.8 percent from 10.0 percent in July because of the recent drop in global crude oil prices.
IRS SUPPORTED: However, IRS did not follow bond yields down on Monday. The five-year onshore IRS rose to 3.61 percent bid from 3.53 percent at Friday's close.