Source: Caixin News
Author: Wang Hong

Currently, expectations for interest rate cuts and reserve requirement ratio reductions are high. Which policy is likely to be implemented first? Experts point out that we have entered an observation period for policy effects, and currently, signals for reserve requirement ratio reductions and interest rate cuts are unclear. The probability of an interest rate cut this week is low, but the possibility of a reserve requirement ratio reduction by the end of the year is relatively high, while interest rate cuts may have to wait until 2025 for an appropriate timing.

From the perspective of exchange rates, experts indicate that domestic interest rate cuts may further increase short-term exchange rate pressure, and the probability of a short-term reduction in reserve requirements exceeds that of interest rate cuts. Recently, the RMB has depreciated against the USD, showing more passive depreciation characteristics. Additionally, industry insiders indicate that the delay in interest rate cuts is also related to stabilizing the financial environment. Experts also point out that the current counter-cyclical adjustment policies continue to exert force, promoting the rebound of domestic economic growth momentum and stabilizing the real estate market, which is the strongest support for the RMB's exchange rate.

The timing for an interest rate cut may be next year, with a higher probability of reducing reserve requirements by the end of the year.

Zhou Maohua, a researcher from the financial department of China Everbright Bank, told the Financial Associated Press, "Currently, the signals for reserve requirement ratio cuts and interest rate reductions are unclear. Considering the factors that disturb the funding situation at the end of the year and the support for banks preparing for the 'New Year kickoff', there is a certain priority for reserve requirement ratio cuts around the end of the year."

‘Currently, we have entered the observation period for policy effects, focusing on transmitting the previously 'strong' policy interest rate cuts and the substantial reduction in the LPR quote in October to the real economy, rather than continuous interest rate cuts,’ said Wang Qing, chief macro analyst at Dongfang Jincheng, to the Financial Associated Press. From this perspective, the probability of an interest rate cut this week is low.

‘Recently, the policy interest rates and LPR quotes have remained unchanged. The fundamental reason lies in the issuance of a package of incremental policies and the economic prosperity rising since October. The official manufacturing PMI index has remained in the expansion range for October and November, with macroeconomic indicators on both supply and demand sides generally trending upward, and the property market is also significantly rebounding,’ Wang Qing pointed out.

Wang Qing also believes that the probability of a reduction in reserve requirements before the end of the year is relatively high, while the interest rate cut may need to wait until 2025 for implementation. ‘Looking ahead to 2025, under the moderately loose monetary policy tone, the central bank will continue to implement significant interest rate cuts, and the policy interest rate is expected to be lowered by 0.5 percentage points, significantly higher than this year's reduction of 0.3 percentage points. At that time, it will guide LPR quotes to follow with reductions, driving down financing costs for enterprises and households comprehensively. It cannot be ruled out that in 2025, larger-scale guidance will be implemented to lower LPR quotes for five years or more, effectively conducting targeted interest rate cuts for residential mortgages. This is a key step to promote the stabilization of the real estate market.'

Is the surge in bullish sentiment in the bond market related to the reduction in reserve requirement ratios and interest rates?

Last week, the bond market continued to be strong, and the yield on 10-year government bonds briefly fell below the 1.7% mark. Wang Qing pointed out that the current bond market is in a "decoupling" phase, and bond yields are susceptible to extreme movements. The recent surge in bullish sentiment in the bond market is relatively less related to expectations of interest rate cuts. The recent significant decline in government bond yields is due to the shift in monetary policy tone from 'steady' to 'moderately loose'; since the fourth quarter, weaker price trends and uncertainties in the macroeconomy next year have fueled the continuous fermentation of bullish sentiment in the bond market.

Researcher Lou Feipeng from Postal Savings Bank Of China believes that the banking system has ample liquidity. After the reduction of interbank deposits and corporate deposit interest rates, the cost of bank liabilities has decreased, which has increased the demand for Bond allocation. At the same time, under the moderately loose monetary policy and expectations of reserve requirement ratio cuts and interest rate reductions, the bullish sentiment in the bond market is once again rising.

A bond market practitioner told reporters from the Financial Associated Press that the recent bullish behavior in the bond market is irrational and is somewhat related to expectations of rate cuts and reserve requirement ratio reductions. "Market expectations for cuts in reserve requirement ratios and interest rates have already peaked, with some traders betting during the policy vacuum period."

Zhou Maohua warned that as bond yields continue to decline, corresponding investment cost-effectiveness is gradually decreasing, and potential risks need to be guarded against. The main concern is that the domestic increase in monetary policy support does not equate to extensive stimulus. Preventing systemic risk is the bottom line. From a trend perspective, since the issuance of incremental policies in September, social expectations have notably reversed, and with the continued strengthening of counter-cyclical adjustment policies domestically, economic recovery is expected to accelerate. Domestic Consumer and internal demand are recovering, supply and demand are approaching balance, prices are steadily rebounding, next year's government bond supply is increasing, and with overseas sticky inflation, attention must be paid to the room for downward interest rates.

The depreciation of the RMB exchange rate is a passive decline, with a greater probability of reduction in reserve requirement ratios than interest rates.

"Recently, the decline in the RMB exchange rate is actually part of a broader downtrend in non-USD currencies. The direct reason is that on December 19th, the Federal Reserve cut interest rates as expected, while significantly raising the inflation forecast for 2025 due to uncertainties surrounding next year's economic and trade policies of the new government in the USA, reducing the expected number of interest rate cuts from 4 to 2 times; moreover, the adjustment or statements from Federal Reserve Chairman Powell after the meeting exceeded market expectations, leading to severe fluctuations in financial markets, where US Treasury yields surged and the dollar rose, resulting in a general decline in non-USD currencies, including the RMB."

Wang Qing pointed out that this suggests the recent decline of the RMB against the USD has a more passive depreciation nature, and is not significantly related to domestic fundamentals, including the widening of the China-US interest rate spread. Currently, the RMB exchange rate against other major currencies is relatively strong and stable, and the risks in the currency market are controllable.

Many industry insiders have stated that, from the perspective of stabilizing Exchange Rates, the probability of a reserve requirement ratio cut is greater than that of an interest rate cut. "The Fed has released hawkish signals and slowed down the pace of interest rate cuts; domestic interest rate cuts may further increase short-term Exchange Rate pressure, necessitating stronger communication with the market," said Zhou Maohua.

An Forex trader told the reporter from the Financial Associated Press that one important factor for the current delay in interest rate cuts may be related to controlling the actual yield of the Renminbi, such as government bonds. Regulation aims to maintain the stability of the financial system and to prevent the price of Renminbi Assets from falling, which are among the reasons.

Recently, the trends of three major RMB basket Exchange Rates indices, including CFETS, have been stable with a slight strength, and there is little necessity for regulatory intervention in the Forex market. It is expected that the RMB middle rate will continue to play a necessary regulatory role in controlling the risk of RMB overshooting, "Wang Qing stated that the current counter-cyclical adjustment policies are continuously exerting force, driving the recovery of domestic economic growth momentum and promoting the stabilization of the Real Estate market, which is the strongest support for the RMB Exchange Rates."

Under the principle of "Taking us as the main", adjustments to the Federal Reserve's interest rate cuts next year or fluctuations in the RMB Exchange Rates will not substantially affect the central bank's moderately loose monetary policy orientation. The choice of the timing for interest rate cuts in 2025 will mainly depend on the needs of domestic counter-cyclical adjustments.

Editor/Rocky