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Recall that the big message from the minutes of the October meeting is that most Committee members thought that conditions may well be appropriate for a rate hike in December. In a way, the ‘surer’ manner in which this was communicated reduced the uncertainty concerning the timing of the first rate hike.
The markets welcomed the news and global equities rallied on Wednesday. However, it would appear that market participants are now questioning whether the positivity was justified. On one hand, S&P 500 is still holding on to recent gains, and remains elevated. The index is up 2.9% on the week so far.
On the other hand, I am not seeing a lot of reasons for the rally to go on, at least for the rest of the year. The stronger USD, weak commodity prices and disappointing US corporate earnings are all factors posing as problems for US shares.
Furthermore, as December looks increasingly likely to be the month for the rate lift-off, we are not seeing more demand for the US dollar. One key reason is the fact that the Fed is drumming home the point that subsequent interest rate increases will be gradual.
In the minutes, there was extensive discussion around keeping the pace of rate normalisation slower than that in previous rate high cycles. Yesterday’s comments from Fed officials again stressed on a gradual pace of rate increases.
This does call into question whether the recent strong rally in USD is a tad overdone. The widespread agreement that the Fed will prefer to move slowly could explain why there is a bit of a pullback in the US dollar yesterday. The dollar index pulled below 99.
The PBOC injected more cash into the financial system yesterday, adding some CNY 20 billion in short-term repurchase agreements. The Chinese central bank also lowered short-term borrowing costs for local financial institutions by cutting its 7-day Standing Lending Facility (SLF) interest rate to 3.25%, and the overnight rate to 2.75%.
While it is tempting to view the latest series of measures as another move to support economic growth, they are actually more of ongoing efforts to reform the financial system in China. Distortion in the allocation of capital in China have driven up private funding costs, as banks remained risk-averse to protect their profits. The rise of non-bank financing has also make policy-making for the PBOC increasingly challenging.
In response, the PBOC is looking to shift to a new benchmark policy rate, as they search for new measures of monetary aggregates and credit measures to improve policy effectiveness. Since 2013, the PBOC has been looking at various short-term rates’ suitability as the new benchmark policy rates. It has also considered a new policy framework, which is the interest rate corridor, to foster effective policy communication and monetary transmission.
The latest PBOC moves are also seen as pre-emptive measures to prevent a liquidity squeeze as the process of IPO resumes. The CSRC said earlier this month that the IPO of 28 companies will be allowed to proceed by the end of the year, after they were suspended in a broader move to stabilise the local equity markets.
Previously, the IPO batches have led to higher money-market rates as investors’ funds were tied up in subscriptions. This time round, the PBOC is keen to avoid the same liquidity drain, ahead of new rules next year which will not require investors to deposit funds equivalent to the amount of stocks they want to subscribe.
Overall, I do not rule out further easing from the central bank to support growth, but I feel that the PBOC is more likely to balance the need to stimulate the economy, with ongoing financial reform efforts, especially on the liberalisation of the interest rates.
Asia is expected to follow the lead from the US session, where market participants are likely to stay on the side-lines today. Some profit taking activity may ensue ahead of the weekend. In Singapore, the STI should continue to trade around the 2900 level, which has been some sort of ‘battleground’ for market participants recently.
Over the past few sessions, we have seen the index swung below and above the level. Specifically, we need to see a sharper rally in the STI, probably above 2950, for bullish momentum to set in. But we are unlikely to see that happening today.
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