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.


Dollar-Bloc Commodity Currencies: More Downside

Our FX strategists expect the dollar-bloc commodity currencies to remain under pressure versus the greenback. China holds the key for the commodity exporting currencies. Despite the soaring stock market, thus far there are scant signs that the Chinese economy is accelerating.


  • Particularly important for the Australian dollar, iron ore prices are still falling. This means that Australia’s terms of trade and currency have yet to bottom. Additional downside for the Australian dollar comes from the prospect of additional RBA rate cuts. Although the central bank held policy steady last week, it maintained its easing bias. Our RBA Monitor remains in “easy money required” territory, warning that more rates cuts are ahead.
  • We also see further downside risks in the Canadian dollar. Our Commodity & Energy Strategy service remains bearish on crude oil. Downside risks to growth could necessitate further rate cuts. Last week’s Business Outlook Survey was broadly weak with future sales growth, employment and investment posting declines.
  • The kiwi ranks the best among the three dollar-bloc currencies. NZ’s economy and commodity basket, which is biased towards dairy products, are much more resilient. Unlike the Australian dollar, which is still overvalued relative to its terms of trade, the kiwi is closer to fair value. Also, the RBNZ does not have an easing bias. Nevertheless, it will be difficult for the NZ dollar to decouple completely from the other commodity currencies.


What To Expect In Q2 2015?

Our Global Investment Strategy service recently published their Strategy Outlook for Q2 2015.

The quarterly report highlights the following points:

  • Global growth should remain broadly unchanged over the balance of the year, as stronger activity in most developed markets offsets a worsening outlook in emerging markets.
  • A modestly pro-risk stance is warranted. Remain overweight global equities and corporate credit, neutral on government bonds, and underweight cash.
  • Global bond yields will remain subdued as reflationary central bank policy takes center stage. The 10-year Treasury yield is heading to 1.5%.
  • Overweight euro area and Japanese equities. Reduce exposure to the U.S. on valuation concerns and margin pressures. An overall underweight in EM equities is warranted, but China deserves to be bought.
  • The commodity supercycle is over. There is little reason for oil or most metals to rebound anytime soon.

The dollar bull market is entering its final innings. While the greenback should be able to extend its gains against the commodity currencies and to a lesser extent, the yen, the pound, and the RMB, it will struggle to rise much further against the euro.

Clients interested in reading the full Report can access it here: Strategy Outlook Second Quarter 2015.

China: The Feedback Loop Of A Bull Market

The tug of war between growth and policy reflation will remain the dominant theme this year, in which weak growth numbers will force policymakers into more aggressive reflation efforts. This is already turning out to be good news for stock prices. Indeed, even though the equity market in China is far less important than in developed countries, rising stock prices will still offer important benefits for the economy.


Rising stock prices increase household wealth and boost confidence, which in turn supports consumer demand. This could be true everywhere, but may have just started to become relevant for China, given the rapid increase in investors’ participation in the equity market in recent years. The numbers of investor accounts in the Shanghai Stock Exchange recently hit 125 million, almost triple the level in 2007 during the previous equity mania. This amounts to over 16% of the urban population, compared with a mere 6% eight years ago. Meanwhile, there has been explosive growth in investment funds in recent years, which has also increased households’ exposure to the equity markets.

The chart above shows that consumer confidence has surged to its highest level in recent years, a highly unusual development considering the weak growth environment. We suspect this has to do with the sharp rally in stock prices and growing participation in stock equity investment. Rising consumer confidence will eventually benefit retail sales.

From policymakers’ perspective, however, a much more important consideration is the funding mechanism of the stock market.