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Conclusion: Absent confirming quantitative signals, we contend that China’s surprise RRR cut is not a leading indicator for broad-based monetary easing in China over the intermediate-term. Moreover, we think it’s important to note that the potential for Chinese growth to reaccelerate due to easier monetary policy is structurally impaired absent a removal of curbs within the property sector.

Over the long U.S. weekend, China surprised us by lowering its benchmark Reserve Requirement Ratio (RRR) for major banks by -50bps to 20.5%. This marks the second time China lowered RRRs in the past three months (we saw a -50bps cut in early DEC as well).

We are surprised by the decision for two reasons:

  1. The breakout in global energy prices since the Federal Reserve pledged [at least] an additional year of easy money (Brent +9.8%; WTI +5.5%) has been quite pronounced and looks to erode a fair amount of intermediate-term downside in Chinese inflation statistics. In the PBOC’s defense, global food prices remain a holdout and that should keep a lid on China’s intermediate-term CPI outlook for now (CRB Food Index -0.4% since 1/25); and
  2. Over the past 2+ months, expectations of monetary easing in China have clearly inflected, as evidenced by the slopes of 1yr O/S Rate Swaps, 1yr Sovereign Yields, and relative pricing in the FX Forwards markets.

 China Lowers RRRs – Now What? - 1

 

China Lowers RRRs – Now What? - 2

 

China Lowers RRRs – Now What? - 3

Not surprisingly, Chinese equities (as measured by the Shanghai Composite Index) closed up in the two trading days following the cut, putting the index at 2,381, or 99bps above our TREND line of 2,358.

China Lowers RRRs – Now What? - 4

We need to see this [potential] TREND line breakout confirmed by further price/volume/volatility data in the coming weeks. A sustained breakout would signal to us that Chinese officials have more coming down the pike in terms of policy easing than we would expect given the two reasons we laid out above.

Interestingly, in conjunction with the RRR announcement, Jin Qi, an assistant governor at the PBOC, did say that “monetary policy will remain prudent in the face of a grim international situation, price pressures, and imbalances in the domestic economy.”

Referring to the aforementioned imbalances, Chinese Premier Wen Jiabao said recently that China will not take its foot off of the brake with regards to the property sector. It is our view that until such curbs are lifted, monetary easing in China will have a limited effect on reflating growth – particularly given the share of fixed-asset investment as a driver of the Chinese economy and the headwinds facing household consumption (accelerating inflation pressures) and net exports (decelerating demand).

China Lowers RRRs – Now What? - 5

Lastly, we show the chart below to help contextualize where China is in its easing cycle. Looking back to the last time China embarked on monetary easing (‘08/’09 period), China used its various money supply levers in different order; of particular note, China lowered its benchmark lending rate (mid-SEP and early-OCT) and deposit rate (early-OCT) prior to lowering RRRs in mid-OCT. The reversal signals to us that it may be prudent to not expect a similar trend of broad-based easing over the intermediate term at the current juncture.

China Lowers RRRs – Now What? - 6

All told, absent confirming quantitative signals, we contend that China’s surprise RRR cut is not a leading indicator for broad-based monetary easing in China over the intermediate-term. Moreover, we think it’s important to note that the potential for Chinese growth to reaccelerate due to easier monetary policy is structurally impaired absent a removal of curbs within the property sector.

Darius Dale

Senior Analyst