Does China's Central Bank Matter More than The Fed?

Wardwell’s Weekly Market Report

I’m pleased to share with you the economic and market brief that I prepare for Pioneer’s investment professionals each week. It’s intended to be short but informative, and I hope you find it useful.

Observations on the Capital Markets – Week Ended June 28, 2013

  • The People’s Bank of China (PBoC) eased slightly; equities rallied and bond yields stopped rising
  • The Federal Reserve (Fed) scrambled to calm the markets
  • The market seems to care more about QE (Quantitative Easing) than about Q1 GDP (1st quarter gross domestic product)
  • Good U.S. business data . . . no reason for the Fed to extend QE
  • No negative surprises in the labor market . . .no reason for the Fed to extend QE
  • Consumers continue to save rather than borrow
  • Residential real estate data still strong . . . too soon to assess impact of interest rate increases

Does the PBoC Matter More than the Fed?

I suggested recently that a second, perhaps underappreciated factor in the bond market sell-off was a short-term liquidity squeeze in China – an effective policy tightening by China’s central bank, the People’s Bank of China.

Concerns about a possible lending/credit bubble — particularly in the “shadow” banking system — in China are not new, and the Chinese government has been talking down credit growth . . . without the desired effect. So the PBoC jerked (hard) on the leash of the banking system (especially the shadow banking system).

Overnight SHIBOR, (the Chinese equivalent of the Fed Funds rate), which had averaged around 3% over the past 18 months, peaked at 13.44% on June 20. That week, the People’s Bank of China told bank officials that they wouldn’t get any assistance in dealing with tightening liquidity conditions and they should scale back their leverage ratios to cope with the cash squeeze. (This tightening caused a global liquidity squeeze which coincided with the Fed’s new QE guidance, exacerbating the sell-off).

On Tuesday, June 25, the PBoC issued a statement saying that overall credit would be adequate — in essence that it wasn’t trying to create a crash, just get the banking system’s undivided attention. The PBoC said it will continue to provide liquidity support to banks that follow government loan policy to maintain money market stability. SHIBOR settled to around 5% at month-end. On Friday, June 28, the PBoC said it “will guide financial institutions to maintain reasonable lending policies” (suggesting we should expect more specific and restrictive guidance from the PBoC in the future). But Tuesday’s comments and the modest easing were enough to put a floor under stock and bond prices and turn markets up in the second half of the week.

The Fed Scrambled to Calm the Markets

The Fed went into maximum spin management mode with appearances by eight officials (Fisher, Kocherlakota, Dudley, Lockhart, Lacker, Pianalto, Stein and Williams) . . . all of whom reiterated Fed Chairman Bernanke’s core message (“we remain accommodative and data dependent”) regardless of their personal policy preferences. No one really said anything new.

The overall impression is that the Fed was spooked by the bond market sell-off. Did it underestimate how much of a bubble had built up? Will it really change policy if the market throws a tantrum? These are not comforting thoughts.

The Market Seems to Care More about QE than about Q1 GDP

Q1 GDP growth was revised down from 2.4% to 1.8%, driven most notably by lower consumer spending and business investment. The weakness in consumer spending doesn’t trouble me, as higher savings are good (see more below). The market’s reaction suggests that it cares more about the Fed than about past economic data . . . or that bad economic news is good news for those who don’t want QE to end.

Good U.S. Business Data . . . No Reason for the Fed to Extend QE

  • May durable goods orders were up 3.6%, rising for a second straight strong month, showing good underlying strength: both aircraft and ex-transportation orders rose. Both unfilled orders and shipments rose; inventories were little changed. The prior months’ data were generally revised up.
  • The Richmond, Texas, and Chicago regional Fed reports were generally strong.

No Negative Surprises in the Labor Market . . . No Reason for the Fed to Extend QE

  • Initial unemployment claims fell from 355k to 346k, which came as no surprise.
  • Hours worked rose 0.1% in May and hourly earnings rose 0.2%.
  • May personal Income rose 0.5%, more than expected, boosted by dividends, interest and social security. Wage and salary income rose a still-respectable 0.3%.

Consumers Continue to Save Rather than Borrow

  • U.S. consumer confidence rose again in the month of June, but May personal expenditures rose only 0.3%. The savings rate rose to 3.2%.
  • Consumer spending estimates for January through April were revised significantly lower, depressing GDP (which measures spending see above), but boosting savings (funds available for future spending).
  • The debt service ratio of U.S. households declined in the fourth quarter to its lowest level since record keeping began in 1980.

Residential Real Estate Data Still Strong . . . Too Soon to Assess the Impact of Interest Rate Increases

  • New home sales rose to a five-year high rate of 476,000/year in May, up 29% from a year ago.
  • The Case-Shiller home price index rose 12.1% year over year (YoY) in April. The FHFA (Federal Housing Finance Agency) home price index rose 7.4% YoY.
  • Purchase mortgage applications rose 2%; refinancing applications fell 5% to the lowest level in almost two years.

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