A report by CYS Global Remit Payment Service Support Team
Resilient USD story | skip to SGD/CNY
Recently, the USD index has experienced a rebound and maintained elevated levels, primarily driven by the diminishing anticipation of aggressive interest rate cuts. Following November of the previous year, market sentiment shifted to price in expectations of impending interest rate reductions by the Federal Reserve (Fed), resulting in a 3% decline in the USD index.
However, since the commencement of this year, better-than-expected U.S. employment and inflation data, coupled with the resilience of the U.S. economy, have prompted a reevaluation, leading the market to recalibrate expectations regarding future interest rate cuts.
Despite various factors contributing to the current rebound and sustained high levels of the USD, it appears to be only a matter of time before the Fed initiates interest rate cuts. The looming question remains: What trajectory will the USD index take in the 'year of interest rate cuts'?
The recent strength of the USD index can be attributed to the postponement of market expectations for the Fed's interest rate cut from March to May. Prior to the Fed entering the blackout period for the Federal Open Market Committee (FOMC), several officials voiced dissent against market expectations of a potential 6 interest rate cut this year.
Consequently, the likelihood of a Fed interest rate cut in March has diminished from over 80% a month ago to less than 50%. The anticipated timing for the initial interest rate cut has been deferred to May. Based on recent economic data, the Fed appears to have the flexibility to take its time. There are currently no indications of an urgent need for the Fed to implement significant interest rate cuts to address economic contraction.
Alongside the subsiding expectations for interest rate cuts by the Fed, the recent strength of the USD has also been temporarily buoyed by the overall performance of non-US currencies, including the EUR, GBP, and YEN. The European economy, notably weaker than that of the U.S., witnessed a recession in the German economy last year. The feeble EURO has consequently conferred advantages to the USD. Data from the German Federal Statistics Office reveals a projected 0.3% year-on-year contraction in Germany's GDP after price adjustment in 2023. The outlook for Germany's economy in the current year is further clouded, with concerns among many economists that the economic output in Germany may continue to decline in 2024.
Currency strength is a relative concept. In addition to the impact of the USD's own interest rate trends, more importantly, the interest rate differential between the U.S. and other countries' currencies. Economic growth and inflation will also affect the exchange rate.
The deceleration in growth may take some time to manifest in the U.S., especially when compared to the Eurozone, the United Kingdom, and other regions where the slowdown is more pronounced. Despite the ongoing battle against inflation, the U.S. economy exhibits robust growth, recording a 3.3% increase in real gross domestic product (GDP) during the fourth quarter. Consumer spending serves as a major driver of this growth, fueled by alleviating price pressures, a strong labor market, and resilient wage growth.
As the U.S. enters 2024, consumers enjoy a solid economic foundation, thanks to a healthy labor market, diminishing inflationary pressures, and consistent wage increases. These factors have defied the predictions of many economists who foresaw a recession in 2023. Consumer spending, a pivotal component of economic growth, remains buoyant even in the face of rising interest rates.
Regarding inflation, the U.S. Bureau of Economic Analysis released data on Friday, January 26, indicating that the core PCE price index, the Federal Reserve's preferred inflation indicator, rose by 2.9% year-on-year in December. This figure was lower than both the expected value of 3% and the previous reading of 3.2%, with a month-on-month increase of 0.2%. The year-on-year growth rate reached its lowest point since March 2021, suggesting that the disinflationary trend in the U.S. continues to persist.
Although the Fed is expected to cut interest rates in 2024, the European Central Bank and the Bank of England are also expected to cut interest rates. Therefore, the interest rate differential between the USD and other major countries’ currencies will not narrow significantly. Against this background, the USD is expected to fluctuate in a range in the next three months. But if the Fed cuts interest rates more than other central banks, the USD could slide further to reflect expectations of narrowing interest rate differentials between the U.S. and other major countries.
At this juncture, our outlook for the trend of the USD in the next 6 months is not excessively pessimistic. We maintain the view that the USD's movement is not strictly unidirectional. Foreseen measures by the Fed aimed at easing may introduce a downside inclination for the USD, while a reduction in these expectations could expose the USD to an upward correction.
We find ourselves embracing a Goldilocks narrative. In this scenario, debt growth, economic expansion, and inflation all align in a state that is neither excessively heated nor too tepid. Our perspective anticipates a synchronized global slowdown, although the likelihood of a recession or a hard landing in the U.S. during 2024 appears improbable.
China’s Stimulus Packages
To enhance the positive economic recovery of the world's second-largest economy, the People's Bank of China (PBoC) has announced a reduction in the deposit reserve ratio by 0.5 percentage points on February 5. This measure is designed to provide the market with approximately CNY 1 trillion in long-term liquidity.
The current Reserve Requirement Ratio (RRR) cut exceeds the magnitudes observed in the past two years, where RRR reductions since 2022 occurred in incremental steps of 0.25 percentage points. This recent RRR cut is substantial, reaching 0.5 percentage points, which is twice the magnitude of previous reductions since 2022. The proportion of cash that banks must hold in reserve against customer deposits is known as the reserve requirement ratio.
This indicates a notable increase in the countercyclical adjustment of monetary policy, surpassing market expectations. Following this reduction, the weighted average deposit reserve ratio of financial institutions will be approximately 7.0%.
The pre-Lunar New Year cut in the Reserve Requirement Ratio (RRR) aims to stabilize liquidity supply and demand in the money market, alleviating fluctuations in market interest rates. Timed on February 5, close to the Spring Festival holiday, historical patterns suggest an imminent rise in liquidity demand as the festival approaches.
Additionally, increased cash demand before the holiday puts pressure on market liquidity. On one hand, the first quarter, being the peak of credit supply, benefits from large-scale liquidity release, supporting financial institutions in issuing medium- and long-term credit. On the other hand, the RRR reduction pre-New Year augments liquidity supply, easing market liquidity and mitigating the impact of the Spring Festival holiday.
As per Bloomberg1, the Chinese government is also strategizing to enlist the help of ‘national team’ to secure approximately CNY 2 trillion (US$278 billion) for market rescue initiatives. These funds primarily originate from the offshore accounts of Chinese state-owned enterprises and will be utilized to acquire mainland-listed stocks through capital exchange channels connecting Hong Kong and the mainland. Additionally, China has earmarked at least CNY 300 billion of local funds for the purchase of onshore stocks through investment entities like China Securities Finance Corp. or Central Huijin Investment Co., Ltd., as revealed by individuals familiar with the matter.
The term 'national team' refers to state agencies purchasing stocks to stabilize the market during significant turmoil in the capital market. The key institutions comprising the 'national team,' based on historical experience, primarily include the following major entities. Firstly, China Securities Finance Corp., established in 2011, primarily provides funds for the margin trading and securities lending business of Chinese securities companies. Secondly, Central Huijin Investment, a part of China’s sovereign wealth fund, established in 2003, focuses on investing in state-owned financial enterprises. Following a sharp decline in the stock market in 2015, Central Huijin Asset Management established a unit to acquire stocks. Thirdly, the State Administration of Foreign Exchange serves as China’s foreign exchange market regulatory agency. Fourthly, the National Social Security Fund. Lastly, large state-backed securities firms.
The most recent large-scale intervention by the 'national team' occurred during the stock market crash in 2015. During this period, the Shanghai Composite Index witnessed a decline of over 40% from its peak in two and a half months, sparking concerns about the stability of China’s financial system. In response, in July 2015, the 'national team' injected billions of dollars into select asset management companies, effectively alleviating market panic.
However, despite the infusion of funds by the 'national team,' the impact at that time was short-lived, sustaining the rise in stock prices for only a few days before a subsequent decline.
If, after the infusion of bailout funds, there lacks a subsequent series of robust and truly effective plans to stimulate the economy and elevate market expectations, the impact of the bailout is likely to be short-lived, lasting at most a few days. Additionally, the funds allocated by the 'national team' for the bailout are likely to target leading stocks, blue-chip stocks, financial stocks, top Chinese stocks, and high-dividend stocks. The 'national team' may not be as discerning towards most small and medium-sized enterprises, potentially limiting the sustained effects of the intervention. The aftermath can be envisioned.
This news comes on the heels of Chinese Premier Li Qiang leading the largest coalition (since 2017) to the recently concluded Davos. The intention was to court the international audience at Davos, eagerly anticipating what Premier Li had to convey. However, disappointingly, his remarks lacked substance, leading to a downturn in stocks. There is a prevailing sense of resignation that substantial changes are unlikely, and the relationship between the U.S. and China is deteriorating. Consequently, investors are opting to exit. They have processed similar information and share a common sentiment. While Beijing disputes their perspective, investors are expressing their disagreement by taking action.
The decline in China's stocks is attributed to the absence of immediate and constructive action from the Chinese government in addressing property debt and local government debts in the near term. Initial optimism in March 2022, where expectations were high for a serious approach, has been met with disappointment among stock investors. As capital gains fail to materialize, some investors have opted to liquidate their holdings.
While Hong Kong has indeed bounced back from the independence protests, it has tied its financial fate to the Chinese economy as a compromise. Presently, there is growing apprehension as the sentiment around the Chinese economy turns extremely pessimistic, causing a downturn in stock equities. In the wake of China's reopening narrative, there were modest levels of optimism in January 2023. By March 2023, the momentum dwindled, and China entered a gradual decline in its stock index, which has since accelerated. As a repercussion, Hong Kong's financial industry is grappling with significant challenges because Beijing, intent on recalibrating to the Common Prosperity agenda, remains indifferent.
In the current context, we believe the current effort to rescue stocks is driven by the approaching China's annual “two sessions” meetings, a politically sensitive period. The primary objective is not necessarily to reverse market sentiment but rather to support the market until the end of those meetings. There is a suspicion that authorities in Beijing are becoming increasingly desperate, focusing on elevating the market solely until then. This approach addresses the symptoms rather than the root cause, a fact that is likely recognized at higher levels.
In 2024, we observe the departure of foreign hot money from China, finding its way to India, the U.S., and Japan. The timeline for its return remains uncertain. Even if these funds do return, the Chinese government is anticipated to attribute it to robust fundamentals in a customary manner, showcasing, Chinese fundamentals are solid, and the capital has returned.' This may lead to investors selling into the rally, exiting with a premium higher than initially expected.
In such a backdrop, how can individuals regain confidence to reinvest for the long term? We believe that the most crucial factor in fundamentally restoring the confidence of private enterprises is to diminish the emphasis on ideology and reintroduce the normal economic dynamics of a market economy. It is crucial to recognize that investing in China today is not grounded in business fundamentals but is rather contingent on regulatory policies that can shift abruptly. While ongoing observation is tolerable, expecting to bottom fish may be overly optimistic.
In summary, we assert that individuals who contend that China can glean lessons from the errors of the West are intellectually misguided. Learning from another country's financial crisis is an experiential process that cannot be achieved without firsthand experience, and at times, nations may need to undergo such crises more than once.
The Chinese officials are not inactive; however, there is a notable absence of transparency and communication regarding their actual intentions and actions. Consequently, we rely on indicators and their responses to the crises that mark the deteriorating landscape as signals for deciphering their plans and the pace at which they are addressing the problem. Faced with this uncertainty, we are inclined to anticipate the worst.