I always say you can’t have a proper rally in EM without China as they are effectively 20% of the index and a much bigger part of sentiment and cross over interest and flow into EM.
Then, of course there is the macro factor that China has historically played – thus it kind of tells you in reverse why it’s been such a tough period for EM. China has been struggling both bottom up and top down. China (FXI, quote) until Thursday had been helping to drive a big rally in Em and outperformance to developed markets.
Which brings us to the weekend’s events: China cut the RRR for banks by 100bps which was the largest move of its kind since the 2008 crisis. It also cut another 100bp for rural financial institutions, 200bp for ADBC and another 50bp for state banks. After the RRR cut announced in February we are now getting more and more convinced that Chia is embarking on a very interesting new phase of policy.
The size and timing of the cut are both important. Size wise, the 1.5trn RNB of liquidity that this has freed up means that China is very concerned about the lending and consumption trends. The PBoC is clearly seeking more flexibility form monetary policy and the timing of the cut comes after a raft of terrible macro data that we thought might just lead to some follow through. They are ready to stand by and react to other data that follows. It seems pretty clear that the PBoC is not done and that drawing a line under 7.0% GDP growth is imperative.
We are of the view that a rate cut will be coming in the 2Q. China unlike many global CBs has some room to operate. They have lending rates at 5.25% and deposit rates at 2.5% and the RRR is 18.5% for large SOEs and 16% for smaller banks. They are also are showing that they want to move away from the FX easing reliance that has caused some concern in the US and other members of the G8.
The immediate impact show be for fixed income to rally and Chinese bond markets while smaller than other major government bond markets have been ignoring the carry trade. This might help. ultimately the benefit is for equities which will attempt to determine where China is truly adding some support to their economy still in a downward trend. In the short term, the trade lower in the local stock markets is more of a reaction to the measures taken Thursday night (our time) when they added to margin requirements and brought more sophistication to the market via shorting measures. We think the market over reacted a bit to this headline but that the same time the local CSI300 and Hang Seng had vertical in their moves. The market was way overbot. We are targeting re-entering the FXI which we sold Monday for a buyback. Watching $48.20 to buy back into $FXI. We stay long $CHL outright.
CSI pausing… but for how long?
