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China Leaves Rates Unchanged

Published 11/20/2020, 05:21 AM

PBOC holds rates as economy remains strong

China left its one and five-year Loan prime Rate benchmarks unchanged this morning at 3.85% and 4.65% respectively. The decision should be of no surprise with China’s economy firing on all cylinders. Even a Covid-19 slowdown from the US and Europe impacting exports would only be a mere flesh wound at this stage, especially with vaccines now on the horizon. If China wants to raise money, they can issue bonds in Europe and have Europeans pay them for the privilege.

Elsewhere the night contained a few dramas. In Europe, Poland and Hungary are threatening to veto the EUR 1.8 trillion budget for 2021 over clauses saying they have to follow the rule of law like the rest of Europe. The situation could also threaten the EUR 750 billion pandemic recovery fund if it continues, despite Poland and Hungary being major losers if both are delayed. Markets have been focussing on the UK Brexit trade talks, but Europe has problems out East as well. The situation has the potential to weigh on the euro and European equities if it continues to evolve.

The UK’s Daily Telegraph has reported that a UK/Europe Brexit trade deal could be announced as soon as this Monday. Financial markets have been pricing this into sterling as a 100% certainty for some time now, with GBP/USD near three-month highs at 1.3250 today. Based on past moves on Brexit-related news, sterling could well surprise markets and leap higher if the Telegraph story comes to fruition. The 1.3500 September high would be the first target, but it would not surprise me at all, if sterling moved nearer 1.3800. UK equities would also outperform.

The profit-taking on long equities and short US dollar positions had been continuing overnight, exacerbated by the news that the US Treasury wanted over $400 billion back from the Federal Reserve in the form of unused CARES Act funds. That provoked howls of protest from the central bank but seemed to be in line with the pre-transition scorched earth policies the outgoing US administration is quietly following.

All was quickly forgiven though after weekly US Initial Jobless Claims spiked higher to 742,000 jobs lost, reversing a trend of improving results. The acceptance that Covid-19’s resurgence in the US to record levels would slow economic activity, as evidenced by the Initial Claims, saw Senate Republicans agree to return to the fiscal stimulus negotiating table. The reaction was immediate, equities reversed losses, the dollar fell, and oil prices also gained.

If nothing else, it proves that the US economy and stimulus packages remain the only game in town for financial markets globally. Still, a USD500 billion at USD2.2 trillion spread is a huge one to bridge. With fears of another spike in Covid-19 across the Thanksgiving holidays next week, and Covid-19 potentially the Grinch that will steal the critical Christmas season, both sides have an incentive to book a policy win.

In Asia, both the Philippine and Indonesian central banks cut rates by 0.25% yesterday, surprising both markets and the author. With regional Asian currencies at multi-month highs thanks to their geosynchronous orbit with China, both took the opportunity to trim rates to stimulate their underperforming economies. With the US dollar expected to fall into 2021, I expect to see more of the same across Asia, particularly from countries such as the Philippines, Malaysia and Indonesia, who have a substantial yield carry.

Both Japan and South Korea reported lower than expected inflation measures this morning, South Korean PPI badly missed, falling by -0.50%. In South Korea’s case, part of the fall can be explained by the massive appreciation of the currency and low energy prices. Japan’s headline number is the continuation of decades of deflation. What both highlights are that the export sectors have carried their recovery, with domestic demand subdued. Both are now grappling with renewed spikes in Covid-19 cases which are expected to erode the domestic economy further. With oil prices now bottoming, those numbers should improve, and a Covid-19 demand shock seemingly inevitable from key export markets, the best of the Japan and South Korea recovery may be behind us for now.

As the week ends, renewed hopes from the US fiscal stimulus talks will dictate direction. Having priced in two years of recovery in two hours after the Pfizer (NYSE:PFE) vaccine news last week, Moderna (NASDAQ:MRNA) and AstraZeneca (LON:AZN)’s announcements seem to have had a declining marginal effect. For sure, there is life still in that trade, but stimulus hopes in the US will take precedence in the short-term, despite the challenges of reaching a sensible agreement. Don’t forget Brexit and the pound either, much as we would all like to.

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