Picture3-150x150Here is a small piece from our strategic macro research partner, MRB, on what some may have missed in the People’s Bank of China move Tuesday.

Yes rates and reserve requirements were cut to combat the tightness in financial markets stemming from a combination of lower nominal growth and higher expected future cost of capital. But the central bank also lifted the cap on rates banks can pay on long term deposits. This is an important move toward  market-based pricing for interest rates (cost of capital and return on capital in the economy) and, by extension, the currency. Reform is difficult, thus the volatility. But, in the long run, these structural changes are good for the economy and investments in China.

Only time will tell whether investors reject the recent moves as “too little, too late” or give policymakers the benefit of the doubt. Our bias lies with the latter interpretation.

In terms of the PBoC’s intervention, the intent was clearly to signal resolve, as it is rare for the PBoC to simultaneously cut rates and the reserve requirement. The MRB Monetary Policy Pressure Gauge has been indicating the need for rate cuts for the past year, so the fourth successive cut in the current easing cycle is consistent with the evaporating inflation pressure and, more recently, with a string of subpar growth data (chart 10). Viewed from this perspective, the thrust of PBoC policy is credible. However, in the broader context of other policies, it is understandable why some investors may choose the opposite spin and smell a whiff of desperation in the PBoC stance.

One detail in the PBoC announcement that attracted little attention may turn out to be the most significant element: the cap on deposit rates over one year was lifted. The latter is consistent with the long-term goal of interest rate liberalization, and had already been signaled. Nevertheless, that the PBoC was prepared to push ahead with deregulation in the midst of what many construe to be a crisis, indicates that reformists are still in charge, at least in that institution.

 

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For information on Alhambra Investment Partners’ money management services and global portfolio approach, Douglas R. Terry, CFA is reachable at: dterry@4kb.d43.myftpupload.com

This material has been distributed for informational purposes only. It is the opinion of the author and should not be considered as investment advice or a recommendation of any particular security, strategy, or investment product. Investments involve risk and you can lose money. Past investing and economic performance is not indicative of future performance. Alhambra Investment Partners, LLC expressly disclaims all liability in respect to actions taken based on all of the information in this writing. If an investor does not understand the risks associated with certain securities, he/she should seek the advice of an independent adviser.