Fed Moving Aggressively on Rate Cuts May Spur PBOC to Ease More

(Bloomberg) — The People’s Bank of China is potentially getting the respite it’s been hoping for from global financial markets, bringing closer a dose of monetary stimulus long awaited by investors and traders.

An unexpected move by China’s central bank two weeks ago to lower interest rates may have been just the start of what some economists now say could be a series of three cuts in total in 2024 — easing on a scale unseen in years. A potential gamechanger is what’s likely a more aggressive path of rate decreases by the US Federal Reserve as fear of recession stalks the markets. 

“The PBOC’s room to lower rates is bigger now” given that traders price in more Fed cuts, said Xu Yongbin, co-chief investment officer of U-Shine Private Equity FD Mgt Co. “I expect the PBOC will at least cut rates one to two times this year, and depending on the economy’s conditions it could cut as soon as September.”

Chinese policymakers fought about a year-long battle to defend the yuan by keeping domestic rates on hold, waiting for the Fed to lower borrowing costs from a two-decade high. A wider rate differential between the US and China could threaten to deepen capital outflows and undercut the local currency.

But a huge rally in the Treasury market has pushed down US yields and took some heat off the Chinese currency. Rate futures show traders are now expecting at least a full percentage point of Fed easing by year-end, starting in September or sooner.

For China, it means one less worry for the central bank — and an opportunity to give the economy a kick. 

Since late last year, the yuan has come under pressure to depreciate, caused by pessimism over China’s growth prospects and a widening gap between US bond yields and local government securities. 

This week, however, the difference between US and Chinese 10-year government bond yields narrowed to the smallest since February, lessening the appeal of Treasuries against their Chinese equivalent.

As a result, some analysts and investors predict China’s central bank may act within weeks. With the Fed now expected to ease two to three times this year, Macquarie Group Ltd. is projecting at least two reductions by the PBOC in the rest of 2024, double the cuts it saw previously. 

The dovish drumbeat is building on a shift in projections that took place after a round of easing in late July, which also signaled a transition to relying on the central bank’s short-term rate as the main policy lever to guide markets. 

At the end of July, economists surveyed by Bloomberg had expected the PBOC’s seven-day rate, as well as the rate on its one-year policy loans, to be unchanged through the end of this year. They only narrowly predicted that Chinese banks would cut their benchmark lending rates again in the fourth quarter. 

The timing is important for China because more rate cuts could help alleviate the debt burden on individuals and companies to stimulate investment and spending.

What Bloomberg Economics Says …

“Fading concern over yuan depreciation – especially if validated by larger than previously anticipated US rate cuts – would clear room for the PBOC to reduce rates to help China’s recovery. The economy needs more stimulus.”

— Chang Shu, chief Asia economist, and David Qu, economist. For full analysis, click here

Even so, the PBOC’s moderate rate reductions in recent years have failed to move the needle for the confidence of borrowers in the face of a persistent housing downturn and a gloomy job market. Such moves instead appear to telegraph that authorities are stepping up support for the economy. 

Fiscal stimulus and aid to the housing sector would be more effective in reviving demand, but they are among the options the government has been reluctant to take on a large enough scale.

To be sure, the PBOC will have to navigate other constraints apart from the currency. Commercial lenders’ profit margins are dangerously narrow, while the effect of previous rate cuts on boosting demand has been limited. 

And the focus for the central bank in recent years has increasingly been on domestic conditions in setting policy. That means the choice now will ultimately depend on the needs of China’s own economy rather than strictly the pace of the Fed’s rate moves.

In the unlikely scenario of a global recession triggered by a hard landing in the US, the risk-averse sentiment could strengthen the dollar, putting more pressure on the yuan and actually reducing the PBOC’s policy room, according to Ding Shuang, chief economist for Greater China and North Asia at Standard Chartered Plc.

Ding is maintaining his call made in late July for a 10-basis point cut to the seven-day reverse repo rate in the fourth quarter of this year and the first quarter of 2025 each. The one-year policy loan rate, known as the medium-term lending facility, could be slashed by double the amount every time.

“If the property sector bottoms out next year, China’s domestic demand could stabilize,” said Ding. “Coupled with a US soft landing, it won’t need to follow the US in every step of its rate cut path.”

–With assistance from Qizi Sun, Katia Dmitrieva and Tania Chen.

More stories like this are available on bloomberg.com