Renminbi Swap: How to understand the upward movement of swap and basis?

Morning FX

Since the beginning of this year, the RMB swap market has been somewhat dull compared to the vibrant spot market. However, recently the USDCNY swap points have seen an upswing, with the 1-year USDCNY swap points rebounding from -2100 to about -1900.

200 points—this is already the largest rebound in the swap market since the start of the year.

On closer examination of the swap curve, you’ll notice this is no ordinary rebound—the largest since the start of the year. For this rise in swap points, interest rate parity (the narrowing US-China interest rate spread) only contributed around 50%. The remaining half comes from the portion of the swap point excluding interest rate parity, also known as the "basis" among traders. At present, the 1Y basis has recovered to above 0, which is quite rare this year.

Clearly, this swap point movement is driven not only by interest rate factors, but also by supply and demand. In the market, state-backed participants’ swap buying at the 1Y tenor is quite evident, while foreign institutions are providing buying in mid-term tenors (3M-6M), among others...

It’s worth noting that although the basis above 0 is already at a high for the year, from a long-term perspective, basis above 0 is actually common. At the ends of 2021-2022, 2023, and 2025, the market experienced positive basis for an extended period.

Interestingly, the basis is significantly inversely related to the spot exchange rate. The reason is that when the RMB’s appreciating momentum is strong, the RMB forward rate often lags the spot rate, leading the market to worry about a rebound risk in the forward USDCNY. As seen in the chart below, when the basis is positive, it is typically a period of strong RMB appreciation momentum.

There’s also a certain uniqueness to this round of RMB exchange rates. Although the current USDCNY spot rate at 6.65 is some distance from historical extremes, due to the inverted US-China interest rate spread, the 1-year USDCNY forward rate has already dropped to 6.45, very close to the historical extreme range (6.3-6.4). Obviously, at this level exporters will be more hesitant when making decisions on forward hedging—after all, these are historically low levels.

Looking at the settlement and sale data, we can see that despite the spot FX settlement surplus remaining high, the forward settlement surplus (forward FX purchase contracts minus forward FX sales contracts) has dropped significantly. This means that the power of forward FX buying is gradually rising (relative to forward FX settlement), which will also add upward momentum to the swap and the basis.