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Is China’s central bank trying to dry up liquidity?
Beijing is tightening credit, putting pressure on Chinese assets and leaving investors to wonder if the ripples will spell trouble for U.S. stocks.
After all, China’s 2015 stock-market plunge weighed on the U.S. and world markets, temporarily wiping out trillions of dollars in market capitalization. Over the eight months that bookended China’s equity slump, the S&P 500 SPX, -0.10% fell 17%, while the MSCI World index XWD, -0.10% which aggregates the values of select stocks in the U.S. and other developed markets, lost around 20% of its value.
China’s interbank lending rates are on the rise in response to Beijing’s efforts to tighten liquidity conditions. The three-month Shanghai interbank offered rate, or SHIBOR, now stands at 4.37%, the highest since April 2015, according to data from the China Foreign Exchange Trade System, the interbank trading and foreign exchange division of China’s central bank.
“The credit deleveraging, while desperately needed, could be enormous and hugely disruptive for itself and global growth,” said Peter Boockvar, chief market analyst for the Lindsey Group, in a note to clients.
Beijing’s push to end easy money is depriving Chinese banks of liquidity and, in turn, crimping financing for private businesses.
The tighter conditions have been blamed for weakness across Chinese assets. The Shanghai Composite Index SHCOMP, +0.06% is down 6.8% since early April, while five-year government bond yields have edged above 3.6%. Bond yields move inversely to prices.
If the past is any indication, the fall in Shanghai-listed stocks could put a lid on the S&P 500’s extended bull run. Moreover, analysts also fear the impact of tighter monetary conditions in China on the wider global reflation trade, a bet that equities, particularly growth-oriented companies, will rise and that bond yields will increase in response to faster growth as well as the potential for a pickup in inflation.
The International Monetary Fund forecast the world economy will grow 3.5% in 2017, the fastest pace in five years.
Gene Frieda, a strategist for PIMCO, said the initial excitement over President Donald Trump’s pro-growth agenda obscured the fact that Chinese credit growth has been the biggest driver of the global economy’s expansion in the past five years. It was the country’s voracious appetite for commodities that propelled international trade volume and also allowed it to serve as a backstop amid the emerging-market slump in 2014, he said.
China’s credit growth has become biggest contributor to the global reflation trade.
The interbank rates, a measure of what banks charge to lend each other unsecured funds over a set period, are important because they signal how expensive it is for financial institutions to make up for temporary shortfalls in reserve requirements.
Risk-hungry regional banks, one culprit for China’s credit binge, are particularly dependent on interbank deposits to expand their balance sheets and ramp up lending to local firms, said Haibin Zhu, chief China economist at JPMorgan in an interview with the Financial Times. It’s one reason why some blame the recent weakness in economic data on tighter money markets.
April’s Caixin purchasing manager’s index for the manufacturing and services sectors fell to a 7-month low of 50.3 from 51.2 in March, hinting at slower growth in economic activity. Some have pointed the finger at tightening money markets.
“China is serious about deleveraging its financial system and corporate balance sheets, and things are going to break in that process as it will elsewhere as quantitative easing gets reduced and rates rise. China’s business activity in April has moderated and we should not just whistle right past that,” said Boockvar.
But others are less concerned. They point out Chinese stocks are much cheaper than before. The Shanghai stock index’s 12-month forward P/E ratio, a commonly used price-to-earnings ratio based on analyst forecasts for the year ahead, was 24.2 in June 2015 but now sits at 13. Any predictions of a stock market blowout would have to be balanced against a market less frothy than it was at its 2015 highs.
Emerging markets don’t follow China’s stock markets as closely as they used to.
“We think that there is less cause for alarm this time around, and that the lack of reaction in other equity markets is largely justified,” wrote Oliver Jones, an assistant economist at Capital Economics. “With valuations now much lower, there’s no longer evidence of a bubble.”