China’s monetary easing supercharges its bond market but leaves harder questions about its economy unanswered
Nicholas Spiro says the decline in China’s currency and the inconsistency in its equities market indicate limited investor confidence in Beijing’s stimulus measures and leave its main dilemma – stimulating the economy even as it deleverages – unresolved
Since the beginning of this year, there have been some sharp movements in global debt markets as the US Federal Reserve, the world’s most influential central bank, withdraws monetary stimulus at a brisker pace.
The most pronounced moves have been in short-term interest rates, which are more sensitive to changes in monetary policy. The yield on three-month Treasury bills, a cash-like instrument, has shot up more than 60 basis points to breach the 2 per cent level for the first time in a decade. The rise in US money market rates has pushed up the three-month London interbank offered rate (Libor), a benchmark for global borrowing costs, to 2.3 per cent, also a 10-year high.
Yet, while these moves are substantial, they pale in comparison with the fierceness of the price action in China’s debt markets since Beijing signalled a shift towards looser monetary policy aimed at shoring up an economy faced with the double whammy of an 18-month-old deleveraging campaign and a rapidly intensifying trade war with America.
A series of measures by the People’s Bank of China has injected significant liquidity into the financial system. Recent steps include a cut in the reserve requirement ratio for commercial banks – the second this year – in late June that unlocked over 700 billion yuan (US$101.8 billion) of liquidity and the provision of 500 billion yuan of longer-term funding in late July through the so-called medium-term lending facility, the largest such operation since the scheme was launched in 2014.
This easing of monetary policy, which has been accompanied by growth-supportive fiscal measures involving tax cuts and infrastructure spending, has turbocharged a rally in China’s debt markets. While Libor has risen steadily, its Chinese equivalent has fallen rapidly.
The overnight Shanghai interbank offered rate (Shibor), the benchmark for Chinese interbank markets, is down 100 basis points since early June to 1.8 per cent, its lowest level since the end of 2015. Its three-month equivalent, meanwhile, has dropped 150 basis points, to 2.8 per cent, its lowest level in nearly two years.
This has brought about a sharp narrowing in the gap between Chinese and US short-term interest rates. The difference between three-month US dollar Libor and its Chinese equivalent has shrunk to a mere 50 basis points, compared with 310 at the start of 2018.
Make no mistake, the most dramatic moves in global debt markets this year have been in China, so much so that foreign investors have been pouring money into onshore bonds despite the 9 per cent plunge in the yuan against the dollar since mid-April.
According to a report by JPMorgan, foreigners bought US$13.5 billion of onshore bonds in June, bringing non-resident purchases in the first-half of this year to nearly US$60 billion, compared with US$52 billion for the whole of 2017.
Yet while these capital inflows are contributing to monetary easing by pushing down interest rates further, they are raising more questions than answers.
The severity of the decline in borrowing costs is fuelling concerns about a sharper fall in the yuan, which is now approaching the psychologically important 7-per-US-dollar level.
While increased foreign demand for local bonds is helping reduce the scope for capital outflows, the rapid convergence between Chinese and US interest rates is putting more downward pressure on the yuan. In a report published last Friday, the PBOC insisted its steps to loosen policy do not amount to “flood irrigation”-style stimulus. Yet for markets, this is half the problem.
This year’s much tamer stimulus measures (in contrast to the more aggressive policy easing undertaken in 2011-12 and 2015-16) are unlikely to deliver a meaningful fillip to the economy and simply reverse some of the sharp tightening over the past year or so.
The increasing volatility in China’s equity markets – the Shanghai Composite Index has just recorded the longest stretch of daily swings of 1 per cent or more since 2015, according to data from Bloomberg – reveals the degree to which markets are doubting the efficacy of the latest stimulus measures.
While the injections of liquidity have been a boon to bond investors, the scale of the domestic and external challenges confronting China’s economy require a lot more than just a collapse in interest rates in order for broader sentiment towards the world’s second-largest economy to improve.
Although Turkey’s full-blown currency crisis has supplanted the yuan and Chinese stocks as the focal point of market anxiety, it has also put emerging markets under greater strain, mostly because of last week’s renewed surge in the US dollar.
Monetary policy activism may be driving a rally in China’s debt markets, but it still leaves many questions about China’s current predicament unanswered, the most important one being how policymakers intend to reconcile the imperative of deleveraging with the more pressing need to shore up a slowing economy.
Nicholas Spiro is a partner at Lauressa Advisory