- "We continue to see evidence of China’s economic reforms"
Christopher Chu, Asian Markets Analyst at Union Bancaire Privée (UBP), explains the key implications of the Central Banks last discussions:
“For most of 2015, investors have been focused on two key issues: the timing of the Federal Reserve’s first rate hike and the degree to which China’s economy was decelerating. The two events are seen as highly critical given the impact of global borrowing costs and driver for the global economy. During the final week of October, major central banks across both developed and developing countries met, consolidating much of the anticipation generated over the summer.
The Federal Reserve met after both the European Central Bank and the People’s Bank of China announced plans to further loosen monetary policies. Sentiment had correctly guessed a no-hike outcome for the Fed given the data relevant softness in job growth momentum, and the less data relevant decision not to schedule a post meeting press conference.
However, markets were surprised when the FOMC released minutes showing that Fed Chair Yellen had stated that the current economic climate remained conducive for a possible hike in December, reflecting a change in tone following the central bank’s September meeting. The confusion has been further exacerbated as two members of the committee have publically spoken against raising interest rates, arguing that a premature hike could lead to more perilous impact. Subsequently, markets moved lower while the USD strengthened.
The FOMC concluded a day before the closing of China’s 5th Plenum, a meeting of top leaders that outlines economic and social policies from 2016 to 2020. Similar to the FOMC, markets were combing through details to see if precedence of economic growth had overtaken attention for much needed reform. Beijing had already announced 3Q15 GDP of 6.9% YoY, better than market expectations but still showing a decline from the previous three month period. The PBOC had also cut interest rates earlier in the week, its sixth cut since November of last year, lowering the one year benchmark to 4.33%.
Emphasis on the growth was maintained, as the meeting stated China’s ambition to double its economy from 2010 to 2020, equaling that of the current US GDP. Based on first half of the decade suggests a minimum annual growth rate of 6.5%, which appears doable. The meeting also reemphasized further liberalization of financial markets and advancing its manufacturing services. However, the biggest surprise came when Beijing decided to relax its three-decade old Thomas Maltheus inspired old one-child policy.
The implications of the last days are numerous, though they unfortunately also raise additional questions. Transpiring is evidence of monetary bifurcation for the two largest economies with the US signaling tightening while China preferring loosening. The reality though is both nations recognize the current global environment is rigid and unable to manage aggressive opposing forces.
In our base case, a December hike by the Fed remains a possibility, given the need for the Federal Reserve to reestablish credibility that has been diluted this summer. However, we could see a likely outcome where the Fed tightens by raising the lower band of policy band, from 0.0-0.25% to 0.125-0.25%. In effect, Yellen maintains the bank’s credence of tightening policies in the calendar year of 2015 without materially impacting borrowing costs. This would also allow Yellen to signal a slower tightening process than previous cycles, while a stronger USD acts as monetary tightening mechanism.
We continue to see evidence of China’s economic reforms, including desire to rebalance the economy away from investment led growth. In addition to cutting interest rates, the PBOC also announced the removal of caps on deposit rates, allowing greater competition among the banks and focus loans towards more productive sectors of the economy while also improving incomes for household savings. In our view, the removal of the one-child policy exists as an important social improvement, assuaging concerns over the country’s aging population. However it does little improve productivity. Additionally, China’s traditional preference for males and unhealthy sex ratio of 120 boys to 100 girls is already placing strains on social stability. Economic implications are already limited, given that Beijing had already allowed couples to have two children provided one partner was an old child”.