Global Rates: China’s slowing growth spills over
The 10bps cut in the 1Y MLF by the PBoC (see here) may have global ramifications on global rates. China’s economy has been facing considerable challenges in recent months but the PBoC has until very recently, refrained from taking overt easing steps. Instead, liquidity (as represented by the 7D repo) has been kept loose. However, the string of weak industrial production, retail sales and fixed assets investments finally changed the equation. The 2015/2016 episode is a ready point of comparison. Back then, the Fed had indicated that it wanted to hike rates four times (25bps each) a year. However, all the Fed could manage was once per year in both years. And that is largely because the Chinese economy is sizable enough to have global spill overs. Amidst RMB weakness and stresses in CNH interest rates, financial conditions deteriorated sufficiently such that the Fed had to slow the pace of normalization.
In the current cycle, the PBoC is also not in sync with the Fed. Having exited loose monetary policy in mid-2021, there was no incentive for the PBoC to tighten even as the Fed (and other major central banks) begin tightening in earnest in 2022. This divergence did put a fair amount of stress (as shown by the deterioration in financial conditions), but the RMB was still relatively stable. Currency and Asia rates movements were considered contained despite the outsized Fed hikes. The issue lies with whether this divergence would widen and if this would trigger another round of destabilization. For now, we are closely watching to see how CNH rates and how the RMB behaves. Thus far, the market reaction seems to be mostly on the rates / yields front where normalization gets ruled out and China’s slowdown gets priced. The upshot is that a major economy is dampening global growth and inflation. Typically, this will not be ignored by US yields. Growth worries will probably cap USD yields for the time being with the 10Y tenor closing below 2.80% last night. If the Chinese economy proves to be much weaker than anticipated or if significant spill over occurs, Fed rate hike bets would be tempered.
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