How did the People’s Bank of China react?
Effective 16 March, China’s central bank cut the bank reserve requirement ratio (RRR) by 50-150bp, freeing up liquidity for the financial system and marking another step in an easing strategy that is open-ended, steady, working with small doses and has benefited the stock market.
The PBoC’s strategy has kept market expectations of liquidity injection alive. With Chinese stocks outperforming global markets since the COVID-19 outbreak, this approach appears to be working.
The PBoC set a 50bp blanket cut for all banks. Banks that have extended between 1.5% and 10% of their loans in the “inclusive finance” category will get another 50bp cut in the RRR (for a total 100bp). This category includes loans to small and micro enterprises, rural loans, loans for poverty alleviation, education assistance and loan guarantees for startups. And banks that have more than 10% of their loans in inclusive finance will get yet another 50bp cut.
How did the US Federal Reserve react?
The US Federal Reserve cut interest rates to zero on 15 March and launched a round of quantitative easing (QE) by buying up to USD 700 billion of Treasuries (USD 500 billion) and MBS (USD 200 billion) in coming months.
With the US futures market trading limit down in Asia after this monetary policy easing, following a volatile week when the Fed cut rates by 50bp on 10 March, there appears to be a different assessment of its strategy.
The Fed’s QE move can be seen as closed-end: it is committing to a fixed amount of asset purchases. This sets market expectations at a certain level of liquidity injection. In my view, this is not helping market sentiment. There is the suspicion that the Fed’s rapid and drastic easing moves within a few days might reflect something bad that the market did not know.
What is the view of the markets?
The Fed’s QE is, in my view, less powerful in affecting the markets than the PBoC’s open-ended approach. Given the upheaval stemming from the global Covid-19 outbreak, the Fed may have to move to increase the size of the new QE programme or shift to an open-ended programme as the situation evolves.
However, monetary easing in the prevailing demand-and-supply shock environment is like pushing on a piece of string, in my view. Cheap credit can only help tackle the demand shock, but not boost supply that is suffering from crushed confidence and the restricted mobility of the factors of production. In other words, massive rate cuts and QE cannot help reverse or stop the physical restrictions to mobility stemming from the pandemic that are disrupting economic activity and confidence.
To boost growth, the world needs more fiscal expansion, and even the monetisation of fiscal deficits in the short term. This may not be positive for all markets, notably those economies that have large fiscal or even twin - current account and budget - deficits.
Scope for more. Does the PBoC have greater firing power?
China still has a strong fiscal balance sheet and can afford monetisation without negative macroeconomic implications. Hence, I still expect that, after the recent 50-150bp cuts in the RRR, the PBoC will cut the requirement by another 100 bp and lower lending facilities rates by 30 bp before June 2020.
The points to note are that:
1) the PBoC remains in a selective and targeted easing mode, so that the resultant increase in China’s debt-to-GDP ratio this year and in 2021 will likely be small
2) so far, the Chinese authorities are determined to revert back to deleveraging and excess capacity reduction after the Covid-19 crisis is settled
3) Chinese bond yields can fall further in the short term.
Chinese stocks can benefit
As for the stock market, the PBoC’s open-ended easing approach is feeding market with hopes for an improving economy. The small doses of monetary easing are prompting mainland investors to chase equity assets, buoying the onshore stock market.
The power of this strategy has been augmented by banks’ rising risk aversion, i.e. their unwillingness to lend. Regulatory restrictions on real estate investment have driven the injected liquidity into the stock market.
In the end, the Chinese economy still needs to deliver the expected results to justify the PBoC’s approach. The market cannot be fooled forever. However, before that day of reckoning, the Chinese stock market will likely benefit from the central bank strategy, albeit with volatility.
Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.
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