How China's Failure To Hike Interest Rates Could Signal A Run For Risky Assets

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Chinese yuan forwards are holding their ground according to Bloomberg, after the Chinese government kept its key interest rate on hold. Expectations for yuan appreciation vs. the U.S. dollar remain modest:Bloomberg:

The contracts reflect bets the currency will gain 1.3 per cent from the spot rate, which was little changed today at 6.7789.

It’s important to note that China has just kept interest rates on hold despite hikes in Australia, Korea, Taiwan, and Thailand, as we’ve discussed on this site before.

It could be that the government is satisfied with its efforts to cool its economic growth so far, and is now less worried about its economy overheating. Property prices and economic growth indeed have both eased over the last few months.

Thus maybe market expectations for China to continue tightening monetary and fiscal (spending) policy through year, ie. via making credit more expensive or by spending less money on stimulus projects, are premature. Perhaps China is happy to keep cruising with easy growth conditions, as shown by the fact they haven’t hiked interest rates like other high-growth nations in the Asia-Pacific region.

By easing they are referring to easier credit availability or more/continued-levels-of government spending.

Source: Jan Hatzius of Goldman Sachs, 20 July

Easier monetary policy or more government spending would be 'good for risky assets.'

'Headline-grabbing measures such as a RRR cut, raising the credit growth target from CNY 7.5trn, infrastructure measures or concrete plans for social housing would have the most immediate effect on prices. Indeed, rumours of easier policy have notably shifted China-related assets in recent weeks, as have official denial of such rumours pushed prices in the other direction.'

Source: Jan Hatzius of Goldman Sachs, 20 July

China could, for example, loosen policy towards allowing credit growth in the banking system

'More 'back-door' easing such as a loosening of some of the credit control measures are unlikely to generate the same sorts of sharp reactions but will still be positive for assets as they become clear.'

Source: Jan Hatzius of Goldman Sachs, 20 July

It might also slow-down adjustment of the yuan vs. the dollar.

'Easier policy in China probably won't derail the Chinese from their recent currency reform, however the speed of CNY appreciation is likely to remain slow.... If $/CNY goes back to being fixed against the Dollar, it will likely cause much complaint from the US administration and raise the possibility of heighted trade tensions.'

Source: Jan Hatzius of Goldman Sachs, 20 July

Expect the U.S. dollar to remain weak

'Easier policy in China is unlikely to change the fundamentals underlying the Dollar however, given that much of the fragility underlying the Dollar is stemming from domestic demand and the US BBoP deficit. Indeed the TIC data out on Friday continued to show sluggish inflows into the US and not enough to finance the current account deficit. Consequently we would still see the Dollar on the back foot on a broad basis including against the EUR and Yen.'

Source: Jan Hatzius of Goldman Sachs, 20 July

But easier monetary or fiscal (spending) policy out of China would be good for stocks

'More broadly, as highlighted by Tim Moe and team, an easing of policy in China is likely to be the key catalyst for equity markets in Asia with the 5% rally in CSI 300 following the NDRC announcement regarding infrastructure programs evidence of this even though the programs are old news.'

Source: Jan Hatzius of Goldman Sachs, 20 July

Easier policy would also be good news for commodities

'As tightening started last summer, it took the steam out of the rally in industrial metals prices and again industrial metals prices dipped on the back of the first RRR hike in January and followed A shares down after the property measures were announced. China easing is likely to reverse these moves.'

Source: Jan Hatzius of Goldman Sachs, 20 July

Thus easier policy out of China would be good news for many markets, though it would increase China's economic overheating risk

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