“In our view, the economy may need more than commitments,” SocGen’s Wei Yao and Michelle Lam wrote, in a chart-heavy report declaring the onset of a “serious but constrained easing cycle” in the world’s second largest economy.
On Saturday, there were more commitments. A statement released following the PBoC’s regular Q4 meeting was replete with references to “prudence” and synonyms thereof. Good monetary policy, the PBoC said, strives to promote “continuity, stability, sustainability and scientifically manages market expectations.” It also “strives to serve the real economy and effectively prevents and controls financial risks.”
That’s all boilerplate stuff. Western central bankers might not use the word “scientifically,” but it’s implicit in everything they say. Economists have spent the last several decades trying to pound a square peg into a round hole by turning economics into a hard science. It’s a futile, misguided effort. In some respects, there’s no such thing as economics.
In any event, the PBoC went on to tout interest rate reform, calling the revamped loan prime rate a success that’s helped smooth monetary policy transmission. LPR, the de facto policy rate which underwent a reformulation in the summer of 2019, fell for the first time in 20 months this week. In the figure (below), you can see when the new rate effectively supplanted the old benchmark (purple line versus the yellow line and the corresponding blue-shaded area).
I called the five basis point reduction a “token gesture.” But it was notable that banks appeared to act of their own accord. MLF, off which LPR is priced, wasn’t lowered ahead of time. Apparently, RRR cuts were enough to encourage banks to lower borrowing costs.
All of this seems pretty dry, but remember, we’re talking about monetary policy in the world’s second largest economy, which is currently grappling with multiple overlapping crises, most of which are tied to Xi’s efforts to put the country on a more sustainable economic path consistent with his “common prosperity” mantra. He’s fond of his slogan (figure below).
The problem (and I’m going to recycle some language from previous articles) is that the cumulative effect of Xi’s multi-faceted regulatory crackdown, the Party’s “zero COVID” strategy, an acute power crunch and Beijing’s property curbs was simply too much. By October, growth expectations crumbled and sentiment deteriorated meaningfully.
China did manage to keep Evergrande’s slow motion default from triggering a systemic crisis, and although Kaisa and other developers are beset, a controlled demolition now seems far more likely than a catastrophic implosion.
Signs of stability (and robust exports) notwithstanding, activity data for November was weak (figure on the left, below). The crucial point is that no one expects growth to inflect meaningfully for the better anytime soon.
“China’s November data showed resilient external demand, easing supply/upstream price pressures but still weak domestic demand,” SocGen said, noting that consumer spending was “lackluster,” while infrastructure investment “failed to rebound” and property activity stabilized, but at “weak levels.”
On Saturday, the PBoC delivered a cautious take. “The global epidemic is still evolving, the external environment is becoming more complex, severe and uncertain and domestic economic development is facing the triple threat of shrinking demand, supply shocks and weakening expectations,” officials said, before explicitly nodding to the burgeoning easing cycle.
The PBoC now deems it “necessary to take the lead,” the statement read, adding that,
A prudent monetary policy should be flexible and appropriate, forward-looking, precise, and autonomous… be more proactive, increase support for the real economy, maintain reasonable and sufficient liquidity, enhance the stability of the growth of total credit, keep the money supply and the growth rate of social financing basically in line with the nominal economic growth rate, keep the macro leverage ratio basically stable, enhance the resilience of economic development, and stabilize the macroeconomic market.
As ever, you have to read between the lines. When it comes to official statements from Chinese authorities related to monetary policy or economic development, your inner tasseographer needs to make mountains of molehills in order to divine the real message. They (officials) won’t just “come out and say it,” so to speak.
With that in mind, the key takeaway from Saturday’s monetary policy statement was the notion that the PBoC will be “more proactive” and “increase support for the real economy.”
That underscores the notion that China did, in fact, reach the pain threshold sometime last month. The RRR cut on December 6 (figure below) and news that the PBoC also lowered the relending rate for SMEs, suggested China had already embarked on an easing cycle, even if officials avoided branding it as such.
Expectations for broad-based easing from China waxed and waned over the course of 2021. An RRR cut in July revived expectations for a pivot, but Beijing was keen to perpetuate the notion that unlike its counterparts in developed economies, the PBoC wouldn’t resort to overt monetary largesse or otherwise “flood” the economy with stimulus.
With the Fed and other developed market central banks committed to a hawkish pivot to battle inflation, the stage is set for a widening policy divergence.
“The marginal easing conducted so far has had an effect, but the piecemeal approach is not enough to sustain the improvement and turn the overall momentum around now that there are also signs of a cooling jobs market,” SocGen went on to assess. The bank expects another 50bps worth of RRR cuts in the first half of 2022 and a 10bps cut to the policy rate.
Nomura’s Ting Lu called this month’s LPR cut “too small to be impactful.” The worst is yet to come for China, he warned, on the way to suggesting the best way for Beijing to push market rates lower is to sell the yuan. Stepping up FX purchases would cap yuan appreciation while adding liquidity to the system and bolstering the PBoC’s war chest at a critical juncture considering ongoing worries about high profile corporate defaults on dollar bonds.
The PBoC is currently engaged in a fairly aggressive campaign to halt a run of relentless currency appreciation. Friday marked the 15th consecutive weaker-than-expected fixing.
Earlier this month, authorities raised the FX reserve requirement and subsequently leaned hard into the fix in an effort to send a message — and I do mean hard (figure below).
It’s obvious the counter-cyclical adjustment factor is back in play, but Beijing likely wants to avoid announcing that publicly. Doing so could rankle Janet Yellen.
The fundamentals argue for a stronger currency, and Beijing is still intent on raising the yuan’s international profile. It’s a tough spot. “A desire for greater CNY internationalization means China will be keen to avoid a sharp CNY fall, though officials are likely wary of the impact of a strong currency on export competitiveness,” TD’s Mitul Kotecha said, adding that because the yuan “is supported by China’s current account surplus and strong inflows, [the] risk/reward is skewed towards more CNY upside in the next few months.”
On Saturday, the PBoC emphasized the importance of “deepening the reform of exchange rate marketization, strengthening the flexibility of the RMB, guiding enterprises and financial institutions to adhere to the concept of ‘risk neutrality,’ strengthening anticipation management, grasping the balance between internal and external equilibrium, and maintaining the basic stability of the exchange rate at a reasonable and balanced level.” (It sounds so easy!)
Ultimately, the message from the PBoC is that more easing is coming. And that’ll be a key consideration for market participants in the new year as developed market monetary policy pivots hawkish. The global cycle is very much tethered to the ebb and flow of China’s credit impulse.
“The room for additional LPR cuts is limited with deposit rates at historically low levels and [considering] the potential drag on bank profits,” Nomura said, but China needs “much more aggressive easing and stimulus measures to directly address bottlenecks” if the economy is going to rebound in earnest.
Expect plenty of references to “targeted” stimulus going forward. Beijing will everywhere and always attempt to dispel the notion that the PBoC is facilitating froth and speculation or otherwise undermining the long-running de-leveraging push with stimulus. But one way or another, easing is coming.
Wouldn’t depreciating the Yuan exacerbate the dollar denominated real estate bonds? Is China not playing the role of Scarecrow and these policy choices playing with fire? It feels like perhaps China has found its own impossible choice and are being forced into a policy mistake the same way the Fed was/is.
I’m not entirely convinced that Xi et al have a full grasp of all their monetary and fiscal tools as they would like us all to believe. I think we’d be fools to think those new to the world of capitalism have any sort of institutional knowledge greater than more established economies.
I’d expect it to take some time into H2 2022 before we really start to see the real damage.