Further Chinese Yield Curve Flattening to 17bps

The Chinese yield curve has flattened even more in the wake of strong inflation data and another hike in Chinese reserve requirements. Earlier today, the Chinese government reported that inflation in the year to May had climbed to 5.5%, the highest in nearly three years, and led by food prices that have risen 11.7%. In reaction, the government announced yet another hike in the reserve requirement to a record 21.5% to slow credit growth and dampen inflation, the Chinese.

Growth is moderating but economic growth is still strong. Industrial production gained 13.3% in the year to May, only marginally lower than the 13.4% rise recorded in the year to April. Retail ales are also maintaining a heady 17% annual rate increase.

There are some storm clouds on the horizon, however. Interest rates are rising and the yield curve is flattening. According to Andy Lees, China’s 2’s – 5’s swap curve flattened to just 17 bps, which will put bank margins under pressure and further slow loan growth. (Bloomberg graphic courtesy of Andy Les)

Just last week the 2-5 swap differential was 23 bps. The last time the curve was this flat was during the panic in 2008. So I am still concerned that the potential for a more abrupt slowing exists. So far growth remains robust.