The People’s Bank of China has kept its Loan Prime Rates unchanged: the 1-year rate is at 3% and the 5-year rate is at 3.5%. These rates were cut in May and have stayed the same through June and July. In 2024, the bank launched reforms to improve how monetary policy supports economic growth. Previously, it used several policy rates, like the Medium-term Lending Facility and Loan Prime Rate, to manage market liquidity.

Shift in Short Term Policy Rate

In June 2024, Governor Pan Gongsheng announced a change. The bank will now use the 7-day reverse repurchase rate as the main short-term policy rate. This move aims to better influence short-term market interest rates and help financial institutions respond more quickly to policy changes. The current 7-day reverse repo rate is 1.4%. Holding the one-year and five-year lending benchmarks signals stability in the near term. This suggests that strategies focusing on stable trading of longer-term interest rate swaps could be beneficial. Derivative pricing should show a lower chance of a major rate change soon. Gongsheng’s recent policy reform shifts our attention to the 7-day reverse repo rate. We believe this will now be the main tool for signaling monetary policy changes. Any movements in this 1.4% rate will likely indicate broader market shifts. Recent data gives a cautious outlook, with China’s official manufacturing PMI for June at 49.5. This marks the fourth month of contraction. We see the current policy hold as a temporary pause, not the end of easing. So, we should consider buying options that might benefit from a potential rate cut later in the third quarter.

Impact on Yuan and Trading Strategies

This monetary position puts downward pressure on the yuan. The offshore CNH is currently trading around 7.28 against the dollar. We expect the central bank to manage this depreciation carefully to prevent capital outflows. Traders should consider currency options to hedge or speculate on a slow, controlled decline instead of a sharp drop. Historically, major policy changes are well-communicated, but this new focus on a short-term rate may lead to more frequent, smaller adjustments. This suggests we should prepare for higher volatility in short-term rates. We could set up trades that benefit from this situation, like selling longer-term volatility while buying shorter-term volatility. Create your live VT Markets account and start trading now.

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