The People's Bank of China may have the long-awaited breathing room it's been seeking from the global financial market, which brings hope for investors and traders for long-awaited monetary stimulus measures.
Two weeks ago, the People's Bank of China unexpectedly cut interest rates, which may be the beginning of what some economists say could be three total rate cuts by 2024 - unheard of in years. As worries about recession hang over the market, the US Federal Reserve may take a more aggressive interest rate path, which will change the market's landscape.
Xu Yongbin, co-CIO of Shentropy Capital, said, given traders' expectations of further rate cuts by the US Federal Reserve, "The People's Bank of China now has more room to cut interest rates." He expects the People's Bank of China to cut interest rates one or two times this year, and possibly as early as September, based on economic conditions.
China's policymakers, in order to defend the yuan exchange rate, are keeping domestic interest rates unchanged and waiting for the US Federal Reserve to lower its highest borrowing cost in twenty years. However, the widening gap between Chinese and American interest rates may exacerbate capital outflows and weaken the yuan exchange rate.
However, the significant rise in the US Treasury market has lowered US Treasury yields, easing pressure on the yuan's appreciation. Interest rate futures show that traders currently expect the Fed to lower interest rates by at least one percentage point before the end of the year, starting in September or earlier.
For China, this means that the central bank can eliminate some of its worries while providing opportunities to boost the economy.
Since the end of last year, due to pessimistic sentiment regarding China's economic growth prospects and the widening gap between US Treasury and local government bond yields, the yuan has faced depreciation pressure. However, this week the difference between Chinese and American 10-year Treasury yields narrowed to the lowest level since February, reducing the attractiveness of US Treasuries compared to Chinese bonds.
Therefore, some analysts and investors predict that the People's Bank of China may take action in the coming weeks. Given the Fed's current expectation of two to three interest rate cuts this year, Macquarie Group Limited expects the People's Bank of China to cut interest rates by at least twice the previously predicted rate by 2024.
This dovish argument is based on a shift in forecasts following a round of easing policies in late July, which also marked the central bank's shift towards relying on short-term rates as the main policy lever for guiding the market.
In late July, economists surveyed by Bloomberg expected that the People's Bank of China's seven-day rate and policy bank loan rates would remain unchanged before the end of the year. They only tentatively predicted that the Bank of China may cut the benchmark loan rate again in the fourth quarter.
For China, timing is critical because further interest rate cuts can help alleviate the burden of debt on individuals and businesses, thereby stimulating investment and consumption.
"The concerns about the depreciation of the yuan are gradually disappearing, especially if the magnitude of the US interest rate cut is greater than previously expected," said Bloomberg economists. "The People's Bank of China is cutting interest rates to help the Chinese economy recover. More stimulus is needed for the economy."
Despite this, the People's Bank of China's moderate interest rate cuts in recent years have not boosted borrower confidence in the face of a sustained downturn in the real estate market and the job market. These measures instead indicate that the authorities are increasing their support for the economy.
Fiscal stimulus and assistance to the real estate industry will be more effective in restoring demand, but these measures are not ones the government is willing to undertake on a large scale.
Of course, the People's Bank of China must also overcome other constraints besides monetary policy. The profit margin of commercial banks is very narrow, and previous interest rate cuts have had limited effect on stimulating demand.
In recent years, the central bank has increasingly focused on domestic conditions when formulating policies. This means that the final choice will ultimately depend on the needs of China's own economy, rather than strictly relying on the speed of the Fed's interest rate adjustments.
Ding Shuang, chief economist for Greater China and North Asia at Standard Chartered Bank, said that in the event of a US economic hard landing triggering a global economic recession (which is unlikely to happen), safe-haven sentiment may push up the US dollar and put even greater pressure on the yuan, which would actually reduce the policy space for the People's Bank of China.
Ding Shuang insists on the late July forecast that the seven-day reverse repurchase rate will be cut by 10 basis points in the fourth quarter of this year and the first quarter of 2025. The interest rate for one-year policy loans (i.e., medium- to long-term lending facility) may be cut by half each time.
Ding Shuang said, "If the real estate industry hits bottom next year, China's domestic demand may stabilize. Coupled with the soft landing of the US economy, China will not need to follow the US's footsteps in cutting interest rates."