Contributed by Jeff Cheah, Strategic Sales Manager
Positive Story Remains for USD | skip to SGD/CNY
Last week we saw USD traded with a firmer tone against antipodeans like AUD and NZD as well as lower-yield JPY. However, we saw the USD losing ground to more hawkish central bank peers like EUR and GBP. On economic data releases, Chicago Board (CB) Consumer Confidence came in firmer than expected at 109.7 (vs 103.9 expected). New home sales data also came in higher at 763k (vs 677k expected). Unemployment claims also came in softer at 239k (vs 264k expected). This gives room for optimism for the greenback to continue to outperform against major currencies’ peers, as a July rate hike by the Fed remains in sight.
At this juncture, we retain a bullish outlook on USD against major less hawkish peers, amid a backdrop of slowing global growth concerns. We flagged the USD upside risk in the previous two editions of market insights. We believe the positive dollar story remains an attractive narrative at this moment on the back of (1) US relative higher yield (2) the Fed is not done hiking interest rates (3) safe haven status amid global economic growth slowdown.
An LPR reduction means mortgage interest rates have fallen, and business loan interest rates have also fallen. For residents who need loans to buy houses, or companies whose corporate loans need to be replaced, this reduces their burden to a certain extent.
On June 13, PBoC lowered the interest rate of the 7-day reverse repo and the interest rate of the standing lending facility in one day, and lowered the Medium Lending Facility (MLF) interest rate on June 15, so this time the LPR interest rate cut has been expected by the market. The market expects several more rate cuts and reserve requirement ratio (RRR) cuts in the second half of the year.
We are of the view that the current problem of China's economy is not a 10 bp rate cut at all when the market interest rate is almost the lowest in history, but that residents' consumption and credit continue to slump. Youth unemployment is at very high levels, while business confidence continues to be at a low. We see sentiments in China souring. If any monetary policy or fiscal policy cannot translate into real gains in both consumption and employment, it will be difficult for the Chinese economy to make a real improvement.
The fact of the matter is that the US is still hiking interest rates, while China is doing the direct opposite. The divergence of monetary policy between China and the United States involves issues concerning feasibility, appropriateness, and effectiveness. To determine whether the monetary policy should be tightened or loosened, it depends on the stage of the domestic economic cycle. When it is time to stimulate, the interest rate will be lowered. When it is time to tighten, the interest rate will be raised.
China chooses to lower its interest rates when the rest of the world is talking about interest rate hikes. It is appropriate, because the Chinese domestic economy is relatively on a sluggish recovery mode, the CPI is at a low level, and the financing willingness of the real economy sector is relatively weak, so interest rates need to be cut to stimulate the economy. It is feasible, because China can go against the Fed in its monetary policy. If we go back to history (in 2005), China has achieved the independence of monetary policy by abandoning the fixed exchange rate and retaining certain capital account controls.
To maintain the independence of monetary policy, the key lies in effectively responding to the pressure of capital outflow. A country that chooses to cut interest rates when the United States raises interest rates will inevitably face the pressure of capital outflows. This is the current situation in China.
Presently, China implements a managed floating exchange rate system. The exchange rate is floating, but it is not completely dominated by the market. When necessary, the central bank will guide the exchange rate to fluctuate within a reasonable range. At the same time, China's capital account is not completely free to flow, which also avoids the impact of large inflows and outflows of capital on the exchange rate.
According to Xue Hongyan, Vice President of Xingtu Financial Research Institute, economic decisions do not go to extremes. Although China can maintain the independence of monetary policy, this independence is usually at the expense of exchange rate fluctuations and the loss of foreign exchange reserves, which is costly.
Therefore, in actual situations, the impact of the Fed's interest rate hike will still be considered and minimized. In other words, during the Fed’s rate hike cycle, the PBoC is also subject to certain restrictions on the pace of interest rate cuts, and will lower rates, but is more willing to use some structural tools to achieve the effect of rate cuts.
According to the PBoC’s definition, structural monetary policy tools refer to what the PBoC uses to guide financial institutions to extend credit to specific fields and industries and reduce corporate financing costs. Public statistics reflect that from 2020 to the end of 2022, the PBoC used nearly 20 structural monetary policy tools or policy arrangements with structural characteristics, with the scale of liquidity injected about RMB 3 trillion.
In fact, since Q4 of 2019, China has been in a cycle of interest rate cuts. MLF is the core policy interest rate tool, and the core driving factor for LPR adjustment. Since 2019 Q4, the one-year MLF interest rate has entered a downward channel, from 3.3% to 2.65%.
From a cyclical point of view, China has already entered a cycle of interest rate cuts. Considering the magnitude and time span of cumulative interest rate cuts, there may be another one to two cuts in the future, but this cycle of interest rate cuts is coming to an end.
XingTu’s Xue Hongyan also raised another valid concern worth taking stock of. From the perspective of maintaining a reasonable bank interest rate spread, interest rates are almost impossible to lower. Every time the interest rate is cut, although the deposit and loan interest rates are lowered, the reduction of the deposit interest rate will accelerate the quantity demanded for term deposits. This resulted in a lower decline in the average deposit interest rate than the average loan interest rate, thereby compressing the bank's net interest margin.
From 2019 Q4 to 2023 Q1, the net interest margin of commercial banks dropped from 2.2% to 1.74%. In 2023 Q1, the non-performing loan ratio of China's commercial banks is 1.62%, indicating that the net interest margin of 1.74% has been reduced and cannot be reduced any further.
Many market observers believe that interest rates are no longer the core determinant. Currently, interest rates are already at a low level, and the financing demand of the real economy sector is sluggish. Enterprises and residents are unwilling to borrow money, not because of high interest rates, but simply because they are unwilling to borrow money.
At this time, it is of little significance to continue to cut interest rates, and it will also affect the sustainable development of commercial banks. Therefore, even if interest rates are to be cut in the second half of the year due to the need for stable growth, the market expects only at most one or two more cuts.
As far as the corporate sector is concerned, domestic demand is weak, external demand has yet to pick up fully, and the superimposed inventory cycle has not yet bottomed out. The willingness to invest is sluggish, and they are unwilling to borrow money to invest.
At this juncture, we see the support of SGD/CNY at 5.3265. We expect more fiscal stimulus to come for the Chinese government to render support to the economy. We believe disappointment in follow-through stimulus will trample any bleak confidence, if any.