The bad news coming out of China’s economy in recent days has been more a series of thuds than a trickle.
HSBC’s widely watched preliminary manufacturing Purchasing Managers Index fell under 50 last month to reach a 32-month low, while foreign reserves are now falling, as well as property prices.
But the silver lining in this downbeat news could be an early Christmas gift for equity investors in the form of a decisive loosening of monetary policy. China could be ready to unleash its own big bazooka, giving equity markets a lift.
Following the move last week to ease the reserve ratio requirements (RRR) for twenty rural co-operative banks 50 basis points to 16%, expectations are growing this is the forerunner of a more general easing.
IHS Global Insight released a note last week titled “And now the deluge? – China starts loosening policy in earnest.” They say last week’s initial cuts demonstrate a clear shift in policy bias and to expect a headline RRR cut around the end of the year
Tinkering with RRR requirements for banks has been a key monetary policy tool for mainland authorities in recent years. Since January 2010 the Peoples Bank of China (PBOC) lifted the RRR twelve times to 21.5%.
This did not prove to be particularly effective in controlling inflation, but it certainly coincided with some dismal performances in the equity market.
Could a reversal in this policy also be a catalyst for mainland equities? Some analysts appear to think so.
According to new research from Sean Darby global equity strategist at Jefferies, the rolling over in foreign exchange reserves last month and the collapse in PBOC bond yields sets the stage for a relaxation in RRR. He has now turned bullish on Chinese markets, since November 7th.
While there is no official word of a change in policy, signs that hot money flows into China are reversing give authorities new room to maneuver with the RRR. It has been kept high in an effort to absorb the excess liquidity coming into the economy. Latest statistics showed the foreign exchange reserve increment in the third quarter shrunk by $50.9 billion from the second quarter.
This trend can be explained as money was attracted into China in part by expectations of both currency appreciation and asset (property) price inflation, as well as an interest rate premium over the U.S. The first two factors now appear to be reversing.
Commercial banks will welcome any reduction in the amount of money they have to keep on deposit at the central bank, which has become increasingly costly. Banks only get 1.6% on their reserves, while the benchmark deposit rate they must pay is 3.5%, leaving a negative spread.
Darby at Jefferies also sees other factors supporting mainland equities. For one, asset allocators are looking for asset classes that are uncorrelated in the current environment. Avoiding contagion from any euro fallout is a priority and here China with its closed capital account is relatively insulated.
Another plus for China is that countries running current account surpluses should be favored as they will be less exposed to sovereign credit market conditions and have more flexibility in policy response.
Darby has in the past been among the first to highlight how a change in mainland monetary policy can have a big impact on equities.
Back in 2009 he highlighted how the state decreed lending spree was effectively quantitative easing mainland-style and was likely to boost equities as it sought to raise asset prices.
The argument was it is possible to have a horrible economy and still have good asset markets. This did indeed lead to a temporary surge in mainland equities.
Despite this, it is hard to ignore the various overhangs facing the economy and stock market.
One worry is the extent of unseen bad loans in the banking system, especially if the property market does tip decisively downwards. Then, much of the respite banks get from reduced reserve requirements could be wiped out by ballooning bad loan provisions, making expanded lending more difficult.
Meanwhile authorities are still not out of the woods with inflation. While inflation has eased in recent months it is still running at 5.5%, and food inflation is over 12%. Any sharp reduction in reserve ratios runs the risk of reviving inflationary expectations.
In its analysis, IHS add a caveat that a sharper-than-expected slowdown in the next two months may lead to a policy overreaction by authorities pushing China into another detrimental boom and bust cycle.
That said, in the short term at least the market could run with the theme of monetary easing. But we will need to see concrete signs a change in policy is real and not just a good sales bite.
No comments:
Post a Comment