China is now starting to initiate the loosening of monetary policy as the economy is showing signs of growth slowing down. Consider the recent PMI readings, which have now dipped below 50 for the first time properly - not a small fake-out we saw a quarter or so earlier. The authorities now see a potential recession as the main threat with exports slowing considerably, instead of inflation fighting which was a front seat in the central banks policy for months. Consider the following from the recent Barclays Capital GEMs Research Newsletter:
- The PBoC’s latest policy report confirmed that policy easing has started, although it may take months before the central bank adopts an overall loosening bias. This shift will probably take place in Q1 12, in our view.
- The timing of the policy change depends on two factors: the future trajectory of the economy and policymakers’ ability to resist political pressure.
- The central bank now aims to achieve stable growth in the money supply, bank credit and total social financing. The recent uptick in bank credit, however, was a response to shrinking off-balance-sheet activities.
- We expect the authorities to focus on controlling systemic risks, especially those related to small enterprises, private lending, shadow banking and local government finance.
- With the increasing importance of cross-border capital flows and off-balance sheet transactions, adjustments of certain policy instruments can be viewed as having been made to stabilise liquidity conditions, not necessarily to affect pace of economic growth.
- Market interest rates could decline, although policy rates are likely to be on hold for now. Currency appreciation may also slow in the coming months as both capital inflows and exports slow.
- There is a risk of a premature and aggressive shift in monetary policy, which would be positive for asset prices in the near term, but negative for growth sustainability in the long run.
I would like to comment on the above points publish by Barclays Research Team. There seem to be a reoccurring pattern of thinking, especially when I watch CNBC Asia or Bloomberg Asia during morning breakfast, where market pundits believe that Asia has a very strong buffer in the monetary policy department. In other words, these guys believe that since China and the surrounding Asian economies pushed interest rates higher during 2009 and 2010, now they have the ability to cut interest rates and therefore stimulate their economies. This even applies to Australia, where our Treasurer Wayne Swan keeps saying the same thing on TV all the time. Therefore, this thought process leads the bulls to conclude that falling interest rates will make risk assets rally sharply.
Honestly, I am not so sure about that. While this type of wonderfully bullish thought process sounds good theory, it might not be as rosy in real life. First of all, cutting interest rates will put pressure on currencies like the Australian Dollar, Korean Won, Brazilian Real and Mexican Peso - and these currencies have strong correlations with risk assets like equities. Second of all, when I see the PBoC turning away from inflation fighting, towards easing - that to me signals that there must be a very important reason for this change. Why? Well it is not as inflation is really falling. Smart people state everyday that inflation is running between 10 to 15 percent annually. It is not as if China "accomplished" its inflation fight.
So in other words, the reason of a policy shift is an urgency to protect the economy that is really slowing down substantially. Super bears have been waiting for a signal to when the Chinese economy and its property bubble might hit the edge of the cliff, so a recent move by the central bank towards easing, has now maybe given that signal. Therefore, further easing by China and Asia in general, could be a strong reason for investors to believe that "shit is really hitting the fan" and press a sell button. On a final note, consider the interesting video below by Mr Chanos on Bloomberg (nothing new):