Danger, Will Robinson!
So as you might have heard, China did not follow the Fed on Thursday by hiking OMO rates. The PBoC kept the reverse repo rate unchanged following the Fed hike, a break with recent precedent and it looks like reason for their reluctance is tied the prospect of economic weakness.
PBOC CONDUCTS 7-DAY REVERSE REPOS AT 2.55%: TRADER
PBOC CONDUCTS 28-DAY REVERSE REPOS AT 2.85%: TRADER
— Walter White (@heisenbergrpt) June 14, 2018
“[Their decision to hold” was a surprise for markets as the previous few times the central bank has immediately followed the Fed’s rise,” Credit Agricole’s Dariusz Kowalczyk wrote on Thursday, adding that "it appears the PBOC decided that growth is slowing and inflation is low and well below target, while money market rates are relatively high, so they don’t want to boost them further.”
Right. And speaking of growth, everything missed today: retail sales, FAI and industrial output. The trajectory here is clear:
“Both industrial output and retail sales rose less than expected in May compared to a year ago [w[while]ixed-asset investment growth in the first five months was the slowest since the data began in 1999, as was the investment in the services sector,” Bloomberg writes, detailing the data deluge, before adding that “the decade-long decline in investment has intensified this year, as policy-makers act to reduce leverage at state-owned companies and local governments.”
Clearly, they’re concerned about the outlook and those concerns are heightened by the threat the Trump will go ahead and impose tariffs on a raft of Chinese goods as early as tomorrow.
“There is no strong signal in terms of the overall policy, but nevertheless market will take it on the dovish side as an initial reaction”, Westpac’s Frances Cheung, head of Asia macro strategy, said of the PBoC’s decision to eschew an OMO hike for now.
It’s also possible that another RRR cut is now in the cards. You’ll recall that the PBoC delivered a cut there in April in what was generally seen as an effort to balance out higher OMO rates and ensure MLF could be repaid with ease.
For their part, RBC thinks an RRR cut of “at least” 100bps is now likely to come “sooner rather than later” in light soft data and the dovish signal from the PBoC overnight. “Other factors supporting a general RRR cut include soft credit data from earlier this week, as well as tighter liquidity conditions amid the deleveraging drive,” the bank’s head of Asia FX strategy Sue Trinh wrote in a note, adding that “China also needs to prop up domestic demand in the face of external demand uncertainties.”
As a reminder, this is always a tightrope walk for China – they’re trying to deleverage while ensuring that credit growth to the real economy isn’t choked off and that’s a delicate balancing act.
“Since April we have seen the government cutting RRR, lowering interbank rate, loosening collateral standards for commercial banks when utilizing MLFs and loosening requirements on deposit deviation, stating the desire to support domestic demand and, equally importantly, not emphasizing the importance of deleveraging (instead referring to ‘controlling’ or ‘stabilizing’ leverage),” Goldman writes in their take on today’s data, before noting that while trade tensions have accounted for Beijing’s lean towards looser policy, “the perception that growth is not uniformly strong, lower-than-expected CPI inflation, and high profile cases of defaults in fixed income markets” may be starting to weigh on policymakers’ decision calculus as well.
In any event, this is always key to watch because China is of course the engine of global growth and trade and is also a key source of credit growth.
Trump won’t be doing anyone any favors if he goes through with the tariff announcement on Friday and it’s also worth noting that the further behind the Fed the PBoC gets, the wider the policy divergence and the greater risk of capital flight.