With the Fed debating whether to keep talking about tapering or finally do something about it - even if that something means injecting another trillion of liquidity into the economy by the end of 2022 while nipping and tucking $10 billion per month here and there - China is starting to move in the other direction.
With China's economy rapidly cooling, as the latest sharp drop the Caixin Services PMI demonstrated, after badly missing consensus expectations and poised on the edge of contraction...
... a move which was predicted here months ago when we discussed the collapse in China's all important credit impulse...
... it is not just traders that are speculating that China's next move may be a rate cut - Beijing itself is starting to make loud noises.
Pouring gasoline into the debate whether Chinese and U.S. monetary policy will diverge further, overnight a former central bank official said that China should guide market interest rates lower to support economic growth and ease funding pressure on local governments.
Reasonable rate cuts also would help create space for the PBOC to tighten policy if needed in the future, in order to cope with an expected weakening in the yuan, Sheng Songcheng, former head of statistics at the PBOC, said in a column published late on Tuesday on Sina Finance, a financial news outlet according to Reuters
"It’s necessary to keep liquidity reasonable and sufficient, and guide the rational and moderate decrease of market interest rates," Sheng said, adding that economic growth is likely to slow to 5-6% in the second half of the year, from an expected pace of around 8% in April-June.
Cutting rate is not just to counteract the coming economic slowdown, it's also to give China more space to hike when the need arises. According to Sheng, policy tightening in the future will help ease depreciation pressure on the yuan caused by rising capital outflows from China once the U.S. Federal Reserve starts to tighten policy from emergency pandemic levels, Sheng said.
Unlike the Fed, which surprised investors last month by signalling it could start raising interest rates in 2023 or even next year, earlier than expected, Chinese officials have pledged to make no sharp policy u-turns and markets expect key rates will be kept unchanged through at least this year. And while a Chinese central bank official said in April that policy changes by the Fed will have a limited impact on China’s financial markets, Beijing appears to be getting increasingly concerned about a world in which the US is hiking while China's economy is too weak to follow.
Sure enough, shortly after Sheng's comments, in the weekly State Council meeting on Wednesday, China's Premier Li announced a few measures to "increase support to the real economy", including "using RRR cuts to support the real economy” and a few other policy measures aiming at increasing income and improving social security support to vulnerable groups of the labor market. Here are key quotes from the meeting:
- In response to the impact on business operations from the fast increase of commodity prices, and under the broad guideline of "avoiding flooding the economy with liquidity", policymakers would use monetary policy tools such as RRR cuts to increase support to the real economy and in particular small to medium-sized companies;
- The statement highlighted the need to push enterprises to pay wages "timely and in full amount", and to increase social security support to "flexible employment" such as employment in the delivery industry.
- For migrant workers, the statement also highlighted the need to enhance support for their health care needs, such as "further improving basic medical insurance settlement of medical expenses incurred by the insured away from home".
As Goldman's Maggie Wei writes, in past experiences, PBOC would usually, but not always, follow up with actual RRR cuts after the mention by the State Council on "using RRR cuts" to support the economy. For example, PBOC cut RRR within one to two weeks after the State Council meeting's hints in 2019 to early 2020, though the exception was in Jun 2020 when PBOC stayed put after the State Council meeting mentioned RRR cuts. That said, the absence of mentioning "using RRR cuts to support the economy" for the past year makes today’s mention notable and probably increases the chance of an actual implementation of the cut in our view. Incidentally, Goldman's baseline expectation is an RRR cut over the next few weeks.
Understandably, Chinese treasury futures rose sharply on Wednesday afternoon on Sheng’s comments (and ahead of the RRR commentary). 10-year bond futures surged by the most in over six months after a former central bank official made the case for a rate cut in the second half of the year to safeguard the nation’s recovery and deal with the Federal Reserve’s future tightening.
10-year bond futures rise as much as 0.42 to 98.72; biggest increase since Dec. 22, 2020, although still well below where China's bond futures traded for much of the post-covid period. At the same time, overnight repo rates rose as much as 16bps to 2.07%, the highest since June 30, 7-day repo rate rises 9bps to 2.12%
To be sure, not everyone is convinced that a rate cut is coming. Ting Lu, chief China economist at Nomura, told reporters on Wednesday that he expected the central bank to maintain a modest tightening stance, with no rate cuts or rises expected in the second half.
“China’s policy response towards the COVID-19 pandemic has been different from the past rounds of easing, and one key factor is the strength in exports so that policymakers did not need to resort to mass stimulus in property and infrastructure sectors,” he said.
Michelle Lam, chief China economist at Societe Generale said that "from the real economy’s perspective, I don’t think we are there yet to discuss rate cuts" adding that we “need to see much weaker data especially on the private-sector recovery.” In Lam's view, “the domestic economic situation should still be a primary focus for monetary policy.”
Lam also said that if China sees rising capital outflows they could reintroduce capital control measures as they did in the past; in fact the aggressive crackdown on crypto may be a hint of the coming rate cuts in China even as the rest of the world aggressively hikes to contain soaring prices.
As for how China - if indeed it does go ahead with a rate cut - it remains a mystery how or why Beijing is convinced that inflation will remain transitory and that a rate cut won't push prices even higher, sparking public unrest and anger.