China faces epic unintended consequences in its efforts to 'manage' everything. As Bloomberg rhetorically asks, what if a central bank cut interest rates and borrowing costs rose?
Well that didn't work out as expected, eh?
The reason is simple - the leveraged-speculative surge into Chinese stocks triggered by the "easy" rate-cuts sparked a major rotation from bonds into stocks - which forced the PBOC to stymie leveraged-trading and implicitly tighten financial conditions dramatically for the stressed corporate bond market.
Since the People’s Bank of China surprised markets with the first benchmark rate reduction in two years on Nov. 21, the five-year sovereign bond yield climbed 15 basis points, that for similar AAA corporate notes surged 37 and AA debt yields jumped 76. While finance companies did start charging less for mortgages, their funding costs rose as the one-week Shanghai interbank lending rate added 37 basis points.
The PBOC move misfired as it triggered an 18 percent surge in the Shanghai Composite Index (SHCOMP) of shares, prompting investors to raise cash by selling bonds and seeking loans, driving interest rates higher. Costs for riskier issuers of notes rose as regulators banned the use of riskier debt as collateral for financing. Investors dialed back expectations for further monetary easing as policy makers seek to cool the stock rally.
“Financing costs moved in the opposite way than the central bank wished,” said Deng Haiqing, Beijing-based chief fixed-income analyst at Citic Securities Co., China’s biggest brokerage.
“The fund flows into the stock market could nurture prosperity in the capital market, but the real economy may not necessarily benefit in the short term,” Haitong Securities Co. analysts led by Shanghai-based Jiang Chao wrote in a note on Dec. 7. “On the contrary, it could lead to further scarcity of funds, leading to an increase in interest rates.”
“The stock market’s siphoning of funds may have threatened deposits even at big banks,” said Li Miaoxian, Beijing-based economist at Bocom International Holdings Co. “The central bank needs to take further action, either by injecting more liquidity, though not necessarily in the form of a reserve ratio cut, or taming the stocks rally, to realize its goal of lowering financing costs.”
China's Irrational Exuberance moment...
The People’s Daily, run by the ruling Communist Party, said on its micro-blog last week that some stock investors weren’t acting rationally, joining the official Xinhua News Agency in highlighting risks from the nation’s world-beating equity rally. That marked a turnaround from three months ago, when official media advocated equity investments.
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Yet again - once again central-planners fall victim to unintended consequence