Did China Just Hint At A New "Shanghai Accord"?

There were a variety of catalysts behind Friday's "Jumbo"-sized, 747-point surge in the Dow, among which renewed trade talk optimism, a stronger than expected Chinese services PMI, a blockbuster jobs report, and of course Chairman Powell's dovish reversal from his hawkish Dec 19 FOMC press conference, in which he not only suggested that the Fed will be more "patient" with future rate hikes and will "listen to markets" as inflation appears to be easing off, but also the Fed's balance sheet reduction is no longer purely on autopilot and may be adjusted depending on the market.

However, one key catalyst that was generally ignored in recent days, and which may have sparked new life in the market's animal spirits, came not out of the Marriner Eccles building but from China, and not just the RRR cut which China announced on Friday.

But first a few words on the required reserve ratio cut: As a reminder, after the market closed, the PBOC announced a 1% cut in RRR in January, split evenly on Jan 15 and Jan 25. While expectations were high for such an event, it was not a major surprise to the market, especially since a significant part of the net total interbank liquidity injection of RMB 800bn will go to replace maturing MLF in Q1, while much of the balance will offset the PBOC's ongoing liquidity drains via reverse repo. 

The central bank also emphasizes that the RRR cut is a way to mitigate seasonal spikes in liquidity demand ahead of the Chinese New Year (falling on February 5th this year), and that monetary policy remains prudent.

As a result, as Goldman notes, "the targeted measures are therefore quantitatively meaningful, but not particularly sizable" especially since the lingering risk that large-scale targeted monetary support could potentially introduce distortions in the system (e.g., under-reporting of loan size) is recognized by the authorities.

So while the RRR cut may have a transitory impact at best on the overall economy - the PBOC said the RRR cut would help the real economy, particularly small/private enterprises - another, perhaps far more important even took place in late December, when the central bank indicated a critical shift in the official monetary policy description at the December Central Economic Work Conference, from “prudent and neutral” to “prudent with appropriate looseness and tightness”. 

While the language sounds fairly similar, the new description is similar to what was adopted in 2015, just as monetary policy eased significantly and ahead of the famous "Shanghai Accord" of late January 2016 when, as the world was careening to a bear market, a coordinated response from G-7 leaders and China sparked a massive rally in stocks as China unleashed another major monetary easing burst which impacted the global economy for the next year. Furthermore, as Goldman adds, "such official policy language, while subtle, can carry important information about the monetary policy stance."

Source: CEIC, Goldman Sachs Global Investment Research

So while traders were focusing on the latest words out of Fed Chair Powell, is the real "risk-on" catalyst the hint out of China that a new "Shanghai Accord" may be imminent? The answer is most likely yes, especially if the upcoming US-China trade talks fail to yield a favorable outcome, as the alternative would be even more pain for China's economy.