Don’t Bet Against The PBoC

Monetary easing will continue to drive a multiple expansion in Chinese shares.


With the latest cut of reserve requirement ratio (RRR), the PBoC is stepping up efforts to ease liquidity conditions for the banking system. Historically, the PBoC has adjusted the RRR by 50-basis-point steps; the latest 100-basis-point cut suggests that the central bank is becoming more aggressive. With the RRR still standing at historically high levels, room for further liquidity easing remains wide open.

Our China investment strategists maintain the view that liquidity easing holds the key for lowering the cost of funding of the banking sector as well as the overall economy. As interest rate deregulation continues to advance, the interbank rate has been an important benchmark for the returns of wealth management products of banks and other financial intuitions, which have increasingly been competing with conventional bank deposits. Therefore, falling interbank rates also depress the return of wealth management products and lower the marginal cost of funding for banks – this in turn allows banks to lower their lending rates. Furthermore, the interbank rate is tightly correlated with short term funding costs within the corporate sector, such as the discount rates of bankers’ acceptance bills. The liquidity easing measures by the central bank so far have significantly lowered interbank rates across the board over the past two months, which should begin to filter into the economy soon.

We expect that the authorities’ reflation efforts will eventually put a floor under growth. Monetary easing will continue to drive a multiple expansion in both A shares and H shares, and investors should not bet against the PBoC’s reflation battle.


Fed Lift-Off Conditions: A Look At Prior Cycles

The Fed’s decision to raise rates will remain data dependent, and liftoff will be delayed if the economic and inflation data continue to underwhelm the Fed’s expectations.


Our U.S. fixed income team recently compared the economic data today with prior Fed liftoff cycles. A few observations stand out:

  • Current GDP growth is below the level that preceded previous Fed liftoffs, especially in nominal terms;
  • Headline inflation is also far lower than in past liftoff cycles, although core PCE inflation is at the same levels seen five months before the 1999 and 2004 Fed liftoffs;
  • Unemployment is close to the levels that prevailed in the run-up to the 1997 and 2004 initial Fed rate hikes, although the growth in labor productivity is well below that of all past cycles;
  • Among conventional measures of economic slack, the output gap is close to the levels of the 1994, 1997 and 2004 liftoffs, while the unemployment gap (U-3 minus NAIRU) was only lower prior to the 1999 Fed liftoff.

Judging by history alone, a Fed liftoff in September 2015 appears pre-emptive with regard to current growth and inflation rates, but far less so when looking at measures of excess slack in the economy. The Fed has downgraded the importance of the latter, especially given that structural trends make it particularly difficult to gauge slack this cycle.