COVID-19 is not the only Worry in China and is a Global Interest Rate Tightening Cycle Underway?
1) COVID-19 cases have fallen in China: Headlines were ablaze when new locally acquired COVID-19 cases hit zero last Sunday. There has been a total of ten locally acquired cases in the five days from Monday but these were obviously less newsworthy. Still, cases have fallen and the outbreak does now appear to be under control. A major port in Ningbo, which is China’s second busiest port re-opened after a two-week shutdown was also an encouraging sign that the COVID-19 outbreak has been quashed, although there still appear to be disruptions in other parts of the country. The cargo terminal at Shanghai’s airport is operating at reduced capacity after COVID-19 cases were found among cargo workers. The capacity constraints suggests that supply disruptions remain and could continue to place upward pressure on prices of certain goods.
2) Question marks remain over the Chinese growth outlook: Although there is better news on the COVID-19 front, there remain pockets of concerns over the outlook. A need for additional liquidity in the Chinese banking system this week should be watched carefully. The People’s Bank of China (PBOC) offered 50 billion yuan into the banking system for three consecutive sessions, about five times the usual daily amount. The official reason was to “maintain stable liquidity conditions at the end of the month”. Although the additional liquidity provided is not a massive volume, there does tend to be a more tangible reason why money markets need additional liquidity, particularly given it isn’t the first time this year that the PBOC has provided this kind of support. It could reflect signs of slower economic growth or lingering concerns about the financial health of certain corporates. A bailout was announced last week for distressed debt manager, Huarong Asset Management but doubts are high that property developer, Evergrande would get the same treatment.
There is an eerie similarity with this situation and the Global Financial Crisis, particularly in the lead up to the collapse of Lehman Brothers – everyone knows there are bad debts lurking somewhere, there’s uncertainty about who is exposed and as a result there is an increased demand for cash. Authorities have a reluctance to provide unconditional support to a troubled corporate because of the message it sends to markets, but its integration within the financial system means that a failure could lead to troubles elsewhere. Moreover, it raises the question of how systemic bad debts may have become, and who could be the next domino to fall if Evergrande was allowed to fail.
3) Global inflation risks remain but likely to remain in certain pockets: Signs of capacity constraints remain around the world and has not been helped with the disruptions at major ports within China. Prices paid as reported by businesses remains high and staff shortages are being reported from the UK to the US. The global shortage of semiconductors is still expected to persist, leading to ongoing constraints to production of cars, computers, smartphones and other electronic goods. The fact that COVID-19 is affecting Asia via restrictions on economic activity more so than the rest of the world adds to the pressure on overall prices of goods. Recently, weather has also added to the disruptions, as a storm near Gulf of Mexico lifted oil prices this week. For the moment, high inflation remains isolated to certain goods, and we would probably still need to see ongoing strength in global demand for widespread inflation to be persistent and less transitory than central banks and economists expect.
4) A global tightening cycle could be beginning as the Bank of South Korea (BOK) becomes the first central bank in Asia to lift official interest rates since the pandemic began: The Bank of Korea (BOK) lifted its policy rate by 25 basis points to 0.75% on Thursday, the first increase since late 2018. The lift comes despite rising COVID-19 cases and a slowing in private consumption. The BOK pointed to strong exports and investment and that it expects “sound growth” and “inflation running above 2% for some time”. There was a vague hint at more tightening, saying that they would “gradually adjust the degree of policy accommodation”. However, we all know that COVID-19 remains a key uncertainty. There are a couple of things to note from this move. Firstly, that a central bank is willing to tighten policy despite the current downside risks from the pandemic - South Korea’s new COVID-19 infections are close to their highest on record and have implemented strict social distancing rules. Secondly, it provides growing evidence that a global tightening cycle is taking hold.
5) US Federal Reserve Chair Powell may clarify policy stance soon: Is the Fed on the verge of tapering? In other words, when will the Fed begin to pull back on monetary policy stimulus? The annual Jackson Hole symposium is a get-together of economy and finance experts from around the world. In the past, it has also been symbolic in announcing policy shifts. However, the fact that this year’s symposium has had be moved to a virtual event highlight how COVID-19 is impacting economic activity. A few Fed officials have been forthcoming over recent days telling markets that October would be a good time to start pulling back asset purchases to be announced at the FOMC’s September meeting including Dallas Fed President Kaplan and Atlanta Fed President Bostic. A clarification by the Fed Chair usually follows comments from Fed presidents, but a more cautious Fed may want to avoid signaling anything as yet. So whatever Powell says or even does not say is likely to get some reaction from financial markets.
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