China Monetary Policy Easing vs. American Policy Tightening?

China – Imminent Cut to RRR

On 7th July, China’s State Council issued an official release¹ that a cut to its Reserve Requirement Ratio (RRR) is forthcoming in order to help the country’s SMEs better deal with rising commodity prices and other input costs. There are two ways to interpret this announcement: first, it’s a positive sign that China’s monetary policy may become more accommodative in the near-term which could lead to greater liquidity in the market though second, it’s becoming clear that China’s strong economic rebound may be stalling and that a cut in the RRR is needed to give companies a boost. Reading the tea leaves, it’s possible that the Q2 GDP print slated for 15th July, may come in weaker than the consensus expectations of 8.0% y/y or 1.2% q/q. The softness may come from the June industrial production (consensus 8.0% y/y) as global consumers shift to purchasing goods to services and domestic retail sales data (consensus 10.9% y/y) as China continues to grapple with a few outbreaks across the country. 

While the announcement does not disclose particular details, I don’t think that this targeted cut in the RRR marks any material shift in the PBOC’s monetary policy. Even if the economy may be slowing recently, it’s still growing at a healthy clip. There are also longer-term headwinds such as the country’s already high debt/GDP ratio and speculative property market boom that will that force policymakers to remain cautious. Overall, I think the portending RRR cut is a positive signal to the market that China’s policymakers remain flexible and sensitive to the economy changing dynamics.

US Employment Update & FOMC Comments

The latest US job report and service PMI data point to a continued healthy economic recovery, though the strength of the rebound appears to fall short of some investors’ expectations: nonfarm payroll rose to +850k in June, the largest increase since August 2020 though the unemployment rate surprisingly ticked up to slightly to 5.9% and the ISM Services PMI edged modestly lower to 60.1.² The UST 10-year yield plunged to a low of 1.3% in recent months following the release of the below-consensus service confidence index.³

The data points to a rebounding US economy driven by a robust vaccination rollout (48.1% of Americans are fully vaccinated) which might partly mitigate the risk of the highly transmissible Delta variants and reduces the chance that the American economy may have to experience further lockdowns.

The latest June FOMC meeting minutes cited the pace of economic recovery as being somewhat ahead of some official’s expectation, and yet the committee also cautioned on the “elevated uncertainty” surrounding the recovery outlook. They reiterated their assessment that inflation is transitory and committed to maintain an accommodative monetary policy until maximum employment and sustained inflation of 2% are achieved.   

The Fed runs on the dual mandates of maintaining maximum employment and stable prices. The latest job report and FOMC minutes suggest that the US economy is recovering and that Fed officials continue to be dovish. The rates market responded to this week’s economic events by pricing in a flatter and lower policy rate curve.

Investment Implications

I remain confident that the Fed will remain accommodative and that any major policy moves will be well communicated with the market long before they actually happen – it’s apparent to me that the market desperately wants the Fed to announce shortly it’s tapering schedule so that a key overhang could be removed. I think US markets will largely shrug off the tapering news. I continue to be optimistic about recovery in the US economy despite some hiccups we may see in terms of COVID cases.

US stocks continue to reach new highs and appear fully valued to me. I favor UK, EU and EM equities – even though the Delta variants continues to be a dominant risk in these economies, the hospitalization and mortality rates in the respective economies appear to be holding steady even with the rise in infections. For example, data from Israel, US and UK have shown that a robust vaccination rate is highly effective in preventing serious illness from the Delta variant. This is positive news. The market has also demonstrated its ability to look through COVID resurgences with a focus back to strong economic growth fundamentals.

This article was authored with contributions from David Xu, Summer Analyst.

_{Investment risks}

_{The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.}

_{When investing in less developed countries, you should be prepared to accept significantly large fluctuations in value.}

_{Investment in certain securities listed in China can involve significant regulatory constraints that may affect liquidity and/or investment performance.}

_{1 http://www.gov.cn/premier/2021-07/07/content_5623109.html
2 https://www.cnbc.com/2021/07/06/us-bonds-treasury-yields-climb-as-the-focus-turns-to-fed-minutes.html
3 https://www.reuters.com/article/us-usa-bonds-quotes/surging-us-treasuries-drop-benchmark-10-year-yield-to-1-3-idUKKCN2ED1K6?edition-redirect=uk}

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