This article was written by Rob Waldner, chief strategist and head of the Multi-Sector team for Invesco Fixed Income.
China’s central bank cut key policy interest rates Tuesday to help calm markets after its recent currency devaluation set in motion a cascade of Chinese and global stock market turmoil. The People’s Bank of China (PBoC) cut interest rates by one quarter of a percentage point and lowered the bank reserve requirement (RRR) by one half of a percentage point. The bank also freed up one-year deposit rates, which will allow greater competition for deposits among lenders. Additional cuts were made to lending rates and reserve requirements of some rural banks and leasing companies. We estimate that around 700 billion of renminbi (US $110 billion) in liquidity could be injected into the system by the reserve cuts.
There may be some speculation that these changes to monetary policy may be the start of a form of “quantitative easing” (QE), a stimulative monetary policy we have seen in the US, Europe and Japan to boost growth. However, we at Invesco Fixed Income do not view the PBoC’s latest moves as a broad monetary program along the lines of QE. While QE would be aimed at “getting ahead” of economic slowdown and deflation, we believe the Chinese authorities appear to be merely treading water, injecting sufficient liquidity to replace lost liquidity due to recent currency interventions. In other words, the authorities appear to be responding to recent market movements, but not more. Moreover, Tuesday’s moves appear to have lagged market expectations. A RRR cut appeared to be in the cards in recent weeks, and onshore markets had been expecting an interest rate cut and removal of the deposit rate cap for some time. Without the element of surprise, markets may have already priced in yesterday’s actions, limiting their impact.
Other tools in the policy tool box?
Sharp drops in the Chinese stock market aside, the general economic slowdown underlying market nervousness appears to be concerning Chinese policy makers. Over the weekend, Chinese President Xi discussed a “two bird approach,” for addressing the economy’s current ills. While the meaning of this approach is yet unclear, we believe it may indicate that President Xi believes both monetary and fiscal measures need to be adopted — and on a bolder and grander scale. President Xi’s upcoming visit to the US in mid-September may be a critical opportunity to gain insight into future policy action.
In the meantime, China’s local bond market does not appear to be showing signs of stress. Shorter-term interest rates have trended up due to the withdrawal of liquidity by foreign exchange intervention. However, medium and longer-term interest rates have remained stable, thanks to the large amount of household money shifted from the stock market into the bond market on the heels of stock market volatility. The RRR cut and large injections of liquidity may provide support for Chinese interest rates overall, but we still expect to see volatility in short-term rates, which are most affected by the PBoC’s currency intervention — which we expect to continue.