Even China is wary of fighting the Fed
In the trade-war years, China has found ways to sidestep all kinds of USimposed constraints on its economy — from curbs on the latest mobile-phone chips to Iran oil sanctions. But even Beijing can’t easily escape the gravitational pull of the Federal Reserve.
Economists took two lessons from China’s economic numbers this week. First, while growth started the year at a healthy pace, more stimulus will likely be needed. And second, it’s getting harder for the People’s Bank of China to deliver it via lower interest rates.
That’s because even as China struggles with deflation, resurgent US prices are pushing Fed rate cuts ever-further into the future — leaving the premium of US 10-year government bond yields over their Chinese equivalents at a record high. For Beijing, lowering rates would widen that differential even more, and add to pressure on China’s faltering yuan, which it’s working hard to defend.
“The government is currently placing a greater priority on exchange-rate stability,” said Arthur Budaghyan, chief emerging markets and China investment strategist at BCA Research Inc.
The risk, he said, is that “the PBOC will ease monetary policy much less than is required for the economy to recover.”
If the Fed conundrum is causing headaches for the world’s second-biggest economy — which operates behind a shield of capital controls — imagine what it’s doing elsewhere.
Across Asia, central banks will have to postpone monetary easing till later this year — if they can manage to do it at all — Morgan Stanley economists concluded this week.
Japan’s yen has slid to a 34-year low against the dollar even after the Bank of Japan raised interest rates for the first time in 17 years, while countries from Indonesia to Korea have stepped in to support their currencies.
The PBOC hasn’t changed its 2.5% one-year policy rate since August, even though consumer inflation is near-zero and producer prices have been falling for a year-and-a-half. Economic growth has skewed toward industry and exports, with household spending depressed by a real estate crisis, and cheaper credit would help shore up demand at home.
But since last year, China has made defending the yuan a higher priority than it used to be. Top Communist Party leaders pledged to maintain a “basically stable” currency during a meeting of the Politburo in July, while President Xi Jinping stressed earlier this year that the country needs a “powerful currency” in order to become a major financial power.
Swings in the yuan could weaken investor confidence in the yuan when Beijing is keen to promote its global role. Use of the currency is disproportionately low in international trade and reserve management, given the scale of China’s economy. The PBOC is also wary of the kind of capital flight that followed yuan devaluation in 2015. The central bank had to spend $1 trillion in foreign reserves to stem the outflow.
A LINE IN THE SAND
All of this has led the PBOC to use an artificially strong reference exchange rate since late last year. It effectively drew a line in the sand at 7.32 per dollar, shifting from a previous approach that aimed to smooth out fluctuations in the currency rather than defending a specific level, according to TS Lombard.
Many analysts expect that strategy to continue, despite some loosening of the fixing rate this week.
“The PBOC is probably hoping that the market will bail it out, like it did at the end of 2023” when the dollar weakened and allowed China’s central bank to stop intervening, said Adam Wolfe, emerging markets economist at Absolute Strategy Research.
The currency defence means the PBOC has deployed other tools to deliver monetary easing, instead of interest-rate cuts that impact the yuan more directly.
Officials have signalled they will lower banks’ required reserves to free up liquidity. The central bank has launched a relending programme to encourage loans that support technology innovation and equipment upgrades.
Wall Street analysts are pushing back the likely date for PBOC rate cuts. Morgan Stanley economists shifted their forecast to the third quarter, from the second quarter. UBS Group AG now expects the policy rate to remain unchanged this year, though it sees room for banks to lower their benchmark lending rate by 10 to 15 basis points, along with cuts to deposit rates.
To be sure, China’s monetary policy has become more autonomous over the years — and there’s a recent precedent for going in the opposite direction to the Fed. In 2022 and 2023, the PBOC cut the one-year policy rate by a total of 45 basis points, even as the Fed was delivering its most aggressive hikes in decades. Back then, Chinese central bankers were ready to absorb the impact of that divergence by letting the yuan weaken, as well as tweaking their capital controls.
What’s more, China has other reasons beside the exchange rate to tread cautiously with monetary easing. It could worsen the country’s debt buildup, and leave the PBOC short of tools if the economy stalls. Since Governor Pan Gongsheng took charge last year, the bank has acknowledged constraints on stimulus and used surprise moves to squeeze more value out of whatever actions it’s able to take.
“Exchange-rate pressures are one factor that has discouraged the PBOC from cutting rates more aggressively,” said Wolfe. In addition, “it seems to think that it should keep some powder dry in case the economy has a more severe downturn.”