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Central bank move unexpected, short-term positive for the yuan
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MOST expected China to continue with liquidity injections via open market operations as well as its pledged supplemental lending facility, its medium-term lending facility and its standing lending facility, in addition to targeted fiscal stimulus. The rate cut is a clear “step up” in the intensity of monetary policy easing and is likely a response to the strong headwinds from the property market correction and the limited potency of previous measures amid the highly leveraged economy.
Most market participants did not expect a rate cut on the view that it would send too strong a signal of policy easing and risk exacerbating the debt and property market overhangs. This action suggests to us that the authorities have become more concerned about the renewed slowdown in growth momentum, as reflected in October data on industrial output, money supply and total social financing, as well as the drop in November’s flash HSBC Purchasing Managers’ Index.
It signals to us that the policymakers are concerned with growth and are keen to keep GDP growth in 2014 close to the official target of 7.5 percent. We are now more confident with our forecast of 7.3 percent GDP growth in the fourth quarter, flat from the third.
Intensified policy easing, while supporting near-term growth, increases the risk of exacerbating China’s weak economic fundamentals, creating bigger problems further out. We will be reviewing our monetary policy outlook, but for now maintain our forecast for a 50 basis-point reserve requirement ratio cut in every quarter from now through end-2015.
We believe the first cut in the benchmark rates since July 2012 will be, at the margin, a near-term positive for the yuan, as it reduces growth slowdown concerns and the associated risks of capital flight. We also see some risk of a flattening of the USD/CNH curve from the rate cut (and the possibility of the market pricing in more cuts). Reduced expectations of a potential sharp China economic downturn are likely to lead to a pick-up in capital inflows, including export over-invoicing, CNH structured flows and the recent shift out of foreign currency deposits from corporates.
As such, we maintain our short USD/CNY NDF (year-end fix) and short USD/CNH (15 January 2015 fix) option positions. That said, at the margin, it may reduce the attractiveness of the yuan from a yield perspective with limited expectations of appreciation.
Zhu Haibin, chief China economist, JPMorgan
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