FX5: China Cuts Rates

Monday February 29: Five-things the markets are talking about

Global stocks continue to struggle amid heightened concerns over China’s currency management. Major Asian indices have finished out the month of February in the red as nothing significant has come out of the G20 meeting held in Shanghai over the weekend.

To date, investors have been lacking monetary guidance from Tier 1 Central Banks in February – they are all back on line for March. Their absence this month has only made market moves that more volatile, with risk aversion the dominant trade. Investors can expect Central Bank communication and actions to dominate proceedings in the first couple of weeks of March.

This week, a number of February PMI’s will be analyzed for clues on growth going forward. Japan releases its January data for industrial output, retail sales, household spending and unemployment. While Australia and Canada post their Q4 GDP reports.

Later this evening, the Reserve Bank of Australia (RBA) is the first of a long line of central bank meets for this month – no change in policy is anticipated.

1. G20 Message Underwhelms

Officials at the world economic gathering on the weekend tried to dispel investor’s worries over China – but it seems they have failed, as risk aversion remains the dominant trade.

Asian equity markets saw red in overnight trade as G20 hardly broke any new ground on coordinating a global response to economic challenges. The communiqué provided more vague rhetoric. It underscored members’ “readiness to respond to emerging risks, explore policy options, and safeguard financial stability.” There was some focus on Chinese Yuan, though IMF’s Lagarde said the message is generally that there will not be a large-scale devaluation.

Nevertheless, People’s Bank of China (PBoC) has maintained its string of weaker CNY fixes for the fifth consecutive session this morning (Yuan mid-point at ¥6.5452 vs. ¥6.5338 prior) with the highest midpoint since February 3 over capital outflow concerns.

2. PBoC Cuts Required Reserve Ratio

China’s central bank cut the amount of cash the nation’s lenders must hold as reserves (just ahead of the NY open to stem risk aversion), stepping up their efforts to cushion an economic slowdown amid plunging equity prices and a weakening yuan.

The required reserve ratio for the banks will drop by -0.5% to +17% (in line with expectations) effective March 1.

Officials indicated they lowered the rate to “guide stable and appropriate growth in credit and create appropriate monetary and financial conditions for supply-side structural reform”.

3. Central Banks Continue To Tussle

Investors are waiting and listening intently for monetary policy clues from the Fed (March 16th), ECB (10th) and BoJ (15th) for later this month.

BoJ Governor Kuroda reiterated that Japanese policy makers stand ready to lower rates further if necessary, monitoring the impact of negative rates on markets and the real economy. The Governor has pledged to continue with negative rates and QE until their +2% inflation takes hold.

Market chatter, coupled with a report from Nikkei last week, continues to speculate that the BoJ could still ease further in March despite the negative rates reaction by investors in late January. Kuroda’s negative interest rate had no material currency impact, apart from the initial brief yen pressure to ¥121.50 on the announcement.

The European Central Bank meet is expected to be a contentious one. Already, German and French board members are sparring about the need for anticipated extra easing measures. Germany’s Weidmann said it would be dangerous to further expand already “highly accommodative” monetary policy given the longer-term risks and side effects of negative rates.

France’s Villeroy said deflation remains the primary risk to the Eurozone, adding more action is warranted if low energy prices materialize into sustainable long-term effects.

Bank of England’s former governor King has also weighed in with a downbeat view of the entire euro zone union, stating EZ is doomed to fail as monetary union. It’s “created a conflict between a centralized elite on the one hand and the forces of democracy at the national level”, producing dangerous consequences.

German 10-year Bunds are at record low under +0.12%- the German curve yields negative through the first nine-years.

4. British Pound Remains Under Brexit Pressure

BoE Governor Mark Carney said that the BoE is not making a “judgment on the consequences” of Britain’s referendum on its European Union membership and nor should they.

The central bank will be taking into account “the movements in asset prices.” The governor indicated that that the moves in the pound (£1.3845) and in options that insure against a fall in sterling “have spiked to levels” similar to those seen in the Scottish referendum campaign.

Dealers noted last week that the cost of some options have hit its most extreme levels since Europe’s sovereign debt crisis. Implied volatility (vols.) had rallied +13.5% vs. +8.4% cost recorded two-months ago.

The BoE will meet on March 17. The Governor has kept the bank’s key rate on hold at +0.5% for almost seven-years and the market yield curve shows a +25 basis-point rise is not priced in for another three-years.

5. Eurozone Prices Fall, Piling Pressure On ECB

Data this morning shows that consumer prices were again lower in February than a year ago (-0.2% y/y). Is the eurozone sliding into chronic deflation? ECB’s Draghi has said that the ECB will not hesitate to act if it believes the recent financial market turmoil or lower prices will weigh further on inflation.

It’s questionable whether the ECB will react, and even if they do, Euro policy makers will find it difficult to gather consensus to act “deeply.”

At its January meeting, some ECB council members said that there could be early signs of such so-called “second-round” effects – cheaper oil is feeding through into wages and other prices, which could lead to a deflationary spiral. Policy makers will have new economic forecasts in March that are expected to show that inflation this year falling far below the +1% estimated in December.

The EUR (€1.0900) is little changed, but did test lower after Eurozone CP print.

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