Macro Intelligence: What’s going on in China?

Stimulus out of China has stoked optimism about a stronger global growth outlook.

In this week's IG's Macro Intelligence installment, we delve into the diverse strategies available to the People's Bank of China, provide a rundown of the recent changes in China's fiscal approach, and examine three markets that are particularly responsive to shifts in Chinese economic strategy.

What are the People’s Bank of China’s policy tools?

Before delving into recent alterations in approach, it's beneficial to comprehend the workings of the People’s Bank of China (PBOC). The tactics employed by the PBOC for monetary management differ somewhat from those of other central banks. Let's look at a few tools available to the PBOC for bolstering China's economy.

• Reserve Requirement Ratio (RRR):

The RRR determines the amount of reserves banks must hold as a percentage of their deposits. Reducing the RRR allows banks to lend more while raising it restricts lending.

The PBOC cuts the RRR last year; it has resisted doing so again lately, probably due to concerns that lower reserves would increase stability risks in China’s banks.

Reserve Requirement Ratio (RRR) chart

• Open Market Operations (OMO):

This is when the PBOC buys or sells government bonds in the open market. When the PBOC buys bonds, it injects money into the financial system, when it sells bonds, it takes it out of the financial system.

OMO is often a more discretionary tool used by central banks to support policy and smooth out markets. China has not relied on it in this cycle to boost the economy.

• Standing Lending Facility (SLF):

The SLF is a short-term lending tool that the PBOC uses to provide special loans to banks. It uses the SLF to manage the amount of money in the financial system.

China reduced its standard lending facility by 10 basis points last week in a bid to support loan-making by banks and inject more liquidity into the markets.

• Medium-term Lending Facility (MLF):

The MLF provides medium-term funding to banks, typically for six months to one year, and helps the PBOC manage the amount of money in the financial system. It also influences the interest rates banks apply to one another.

The PBOC cut the rate on these loans to banks by 10 basis points last week

Medium-term Lending Facility (MLF) chart

• Loan Prime Rates (LPR)

The PBOC has the ability to move interest rates by adjusting its Loan Prime Rates. This includes the one-year and five-year rates which influence borrowing and investment decisions.

The LPR is the rate most similar to other central banks’ key policy rates.

Loan Prime Rates (LPR) chart

The PBOC cuts rates as China fights to boost recovery

While China’s re-opening at the beginning of 2023 stoked tremendous optimism, the recovery has proven underwhelming. The so-called “consumer-led” recovery has delivered only modest returns, with China’s policymakers (so far) avoiding the massive pump-priming of the economy typical of previous recoveries.

So weak has been the recovery, and unlike the rest of the world, China’s economy is on the verge of falling into deflation. Recent price data revealed a paltry 0.2% year-over-year expansion in consumer prices in May, while producer prices are falling are an annual pace of 4.6%.

This is a deeper drop than what occurred during the initial lockdowns at the start of the COVID-19 pandemic.

China producer price changes and inflation rate chart

In response to flagging economic activity, the People's Bank of China has eased policy in recent weeks.

It kicked off stimulus by lowering the rate on seven-day reverse repos and the Medium Term Lending Facility (MTLF) in a bid to boost market liquidity. More importantly, the central cut its one-year and five-year Loan Prime Rates by 10 basis points each to boost borrowing and investment.

Despite running higher into the news, the cuts failed to deliver a boost to markets upon their announcement.

The underwhelming response was for two reasons. First, some in the markets had expected a 15-point cut to the five-year LPR. Secondly, China held a State Council meeting on Friday and, despite leaks to the contrary, failed to outline any immediate fiscal support for the economy.

Three markets to watch

• AUD/USD

The Australian dollar rallied in June on a mix of narrowing interest rate differentials, improved global risk sentiment, and a lift in commodity prices following China’s moves to stimulate its economy.

The AUD/USD has pulled back this week, following some “less-hawkish” RBA minutes, which has thrown doubt over the timing and size of the central banks' next hikes.

Resistance is at 0.6900 currently, which, if broken, may open a run toward the 70–handle. Currently, the pair is testing previous resistance and now support at 0.6790.

AUD/USD daily chart

• Fortescue Metals Group

A near 20% rally in iron ore prices off the back of hopes of increased Chinese demand has boosted Fortescue Metals Group shares.

The daily RSI is showing upside momentum but perhaps slightly overbought conditions. Ultimately, the stock is range bound. Firm resistance is just above $23 per share. A confluence of support levels can be seen at $21.40.

Fortescue Metals Group daily chart

• China A50

Although rallying into the news of more PBOC stimulus, Chinese equities unequivocally remain in a downtrend. A series of lower highs and lower lows define the long-term price action, while in the short-term, the price is carving out a downward trend channel.

Trendline resistance is around 13,100, which, if broken, could open a rally towards 13,500. Meanwhile, buyers could emerge in the low 12,000s.

China A50 weekly chart