24 June 2019 Issue 814
Global Market Commentary
- US: Sino-US trade war has eased. US President Trump said on Twitter on Tuesday morning that he had a “very good phone call” with Chinese President Xi Jinping. Besides, the Fed gave up the wording of “keep patience” in the statement of this meeting, which made the market expects the Fed will cut interest rates soon, driving up the stock market. Over the week, the Dow rose by 2.41% to 26,719.13. The S&P 500 index rose by 2.20% to 2,950.46. The Nasdaq rose by 3.01% to 8,031.71 points.
- Europe: European Central Bank (ECB) President Draghi said that if inflation does not return to the target level, the central bank will once again relax the policy, which consolidate the market’s expectation that the ECB will introduce more stimulus measures soon. For the whole week, the UK’s FTSE 100 index rose by 0.84%, the German DAX index rose by 2.01%, and the French CAC40 index rose by 2.99%. The STOXX 600 index rose by 1.57% for the week, reporting 384.76 points.
- Asia: The Sino-US trade war has eased, boosting the Asian stock market. Besides, US President Trump said on Twitter on Tuesday morning that he had a “very good phone call” with Chinese President Xi Jinping, which benefits the Asian stock market. Over the week, the Nikkei 225 index rose by 0.67 percent to 21,258.64 points. The MSCI Asia Pacific Index rose by 2.60% to 159.24 points.
- US: Federal-funds futures market to place a 100% probability on a reduction of at least 25 basis points in the central bank’s target rate at the next FOMC meeting at the end of July. Besides, the Fed abandoned to use “keep patience” in the statement of the meeting, which raised market expectations on interest rate cuts. For the whole week, the yield on the US 10-year government bond fell by 3 basis points to 2.056%.
- Europe: European Central Bank President Draghi said that ECB will once again relax the policy in case inflation does not return to the target level, which makes funds flow from the bond marketa into the stock markets. For the whole week, the German 10-year bond yield fell by 3 basis points to -0.286%.
- Oil: The US-Iran relations are tense, U.S. drones are being shot by Iran. The New York Times reported that Trump had ordered air strikes against Iran, but he withdrew orders soon. The tension between US and Iran caused oil prices rise. Over the week, New York oil futures rose by 8.83% to close at $57.43 a barrel.
- US dollar: The Federal Reserve kept interest rates unchanged this week, but the market expects there will be an interest rate cut in next month, weakening the US Dollar index. For the whole week, the Dollar Index fell by 1.386% to 96.220.
- China: The Fed keeps the interest rates unchanged. However, it is expected that there will be an interest rate cut in July. Besides, the Sino-US relations eased, which benefits the yuan. For the whole week, the yuan rose by 0.707% against the US dollar at 6.875.
- US: On the occasion of the upcoming Sino-US meeting in the G-20 Summit in Japan this week, the US Department of Commerce is blacklisting five Chinese organizations involved in supercomputing with military-related applications.
- US: The Trump administration plans to announce more sanctions against Iran on Monday, but Trump claimed that he is prepared to hold talks with Iranian leaders without any preconditions.
- U.S: Trump denied that he had threatened the Fed Chairman Powell with a demotion, but stressed that he had the right to do so and reiterated his criticism of Powell.
- Euro-zone: Informed person said that European Central Bank President Mario Draghi told EU leaders that if the economy does not improve and inflation level does not return to the target level, additional stimulus measures will be needed.
- Euro-zone: The EU is making a plan to deal with Boris Johnson as the British prime minister, with the goal of not contacting him for as long as possible. Johnson promised that if he becomes prime minister next month, he will immediately begin to renegotiate the Brexit agreement in order to leave the European Union on time on October 31.
- Euro-zone: Markit data showed that the initial value of the Manufacturing Purchasing Managers’ Index (PMI) in the Eurozone in June was slightly improved from 47.7 in May to 47.8, but it is still lower than the market expectations of 48.
- Japan: According to Nikkei/Markit data, the initial value of the Manufacturing Purchasing Managers’ Index (PMI) in Japan in June deteriorated from 49.8 in May to 49.5, lower than the market expectations of 50.
- Japan: Japan’s Ministry of Finance announced that, without seasonal adjustment, Japan recorded a trade deficit of 9671 billion yen in May, increased by 67.5% year-on-year, less than the market expectations of 1.2 trillion yen trade deficit.
- South Korea: South Korea’s central bank data showed that South Korea’s Producer Price Index (PPI) in May slowed to zero growth from 0.3% growth in April, lower than the market expectations of a 0.5% increase.
|China Market Commentary|
|• Huawei sued the US Department of Commerce for a return of telecommunications equipment that has been seized for nearly two years. In addition, FedEx rejected a Huawei mobile phone package sent from the United Kingdom to the United States.
• Ma Hui, Minister of the Chinese Embassy in the UK, told the Daily Telegraph that if the UK excludes Huawei from its new 5G network, the trade agreement between China and the UK may be at risk.
Will China follow if US cut interest rate in July?
Obviously, US is not the first country to initiate the cut in the current global interest rate down cycle, neither it will be the last one. With the Fed’s monetary policy announcement on Wednesday that opening the door for a series of potential rate cuts in the remaining of 2019 and 2020, investors have started to believe that the Fed’s actions are also possibly opening the door of cuts for more countries. Now, the question is who will be the next one?
In fact, fears that a protracted Sino-U.S. trade war could drag the global economy into recession have prompted rate cuts in Russia, Australia, New Zealand, India, Philippines and Malaysia since the beginning of this year. The European Central Bank (ECB) recently has also signalled the bank could roll out fresh stimulus and easing as soon as its next policy meeting in July. Market now speculates that China will be the next to follow if US start to cut rate in July to avoid currency appreciation and stay competitive in exports. A Bank of America Merril Lynch economist even expect that the PBOC may cut rate more than the two times currently anticipated, if the trade war were to intensify.
But having said that, lowering actual interest rate are not necessarily achieved through lower the benchmark rate, and thus it’s not a must for PBOC to lower the country’s benchmark rate as it has not cut its benchmark one-year lending rate of 4.35% since the last downturn in 2014-15, when China cut its benchmark six times. Instead, the PBOC in this cycle slashed the banks’ reserve requirement four times last year and once more in January this year, pushing the RRR ratio down to 13.5% from 15.5% a year ago. Likewise, the PBOC has injected gobs of liquidity in the financial system via its one-year medium-term lending facility (MLF) in February and May this year, while it also regularly provides liquidity to the system via 7-day reverse repo and open market operations. For instance, the volume-weighted average rate of China’s benchmark overnight repo for banks fell to 1.1% on last Friday, the lowest level since June 2015.
A key reason that China did not cut its benchmark rate this time as the move is not in line with the general direction of interest rate marketization reform, i.e. letting markets determine rate, a lower or higher actual interest rate according to risks. Meanwhile, the whole financial system of China is closely monitored. Banks in China still heavily rely on the PBOC’s published benchmark to price loans, and they remained reluctant to take on more credit risks amid the current system. As such, cutting the benchmark rate may not really flowing through to the broader system. It won’t necessary help the private sector or small companies that really needs these funds, and the rate cut action will mostly affect the mortgage rates or simply benefits the state-owned enterprises.
Besides, cutting benchmark rates may not shore up the economy as expected, but may create other broader policy consequences including pressure on the currency, spurring capital outflows, and even inflating the property market. With these concerns, the PBOC has been cautious to see benchmark rates cut as the last resort, and now these risks should be somewhat lessened as US is expected to lower its Fed fund rate by 75-100bps over the next 6-12 months.
All in all, we believe the Fed’s potential rate cuts just provides another flexibility for PBOC to choose among which policy tools to use to tackle its slowing economy. It should not become a pressure for China to follow, but China should take this great opportunity to further enhance its interest rate marketization reform. Of course, if trade war eventually heats up severely and economic data become ugly, a benchmark rate cut has always been a good action to take.