Starting from September 27, the People’s Bank of China (PBOC) lowered the reserve requirement ratio (RRR) for financial institutions by 0.5 percentage points. Following this adjustment, the weighted average RRR will be approximately 6.6%. In conjunction with this announcement, the central bank also lowered the interest rate on 7-day reverse repurchase agreements from 1.7% to 1.5%.

The announcement emphasized the PBOC’s commitment to a supportive monetary policy stance. The bank aims to intensify monetary policy adjustments and enhance the precision of its interventions to create a favorable monetary and financial environment for stable economic growth and high-quality development in China.

At a press conference, PBOC Governor Pan Gongsheng stated that the recent RRR reduction would provide around 1 trillion yuan in long-term liquidity to the financial markets. He also indicated that further reductions of 0.25 to 0.5 percentage points may be considered before the end of the year, depending on the economic situation.

Stock Index Performance since announcement

1. Equity Markets:

• Positive Sentiment: Typically, a cut in the RRR is viewed positively by equity markets as it signals increased liquidity and potential for higher corporate earnings. Investors often react by buying stocks, particularly those in sectors that benefit directly from increased lending, such as real estate, construction, and consumer goods.

2. Stock Index Performance (Data as of market close from September 25 to September 27, 2024)

Ø  Hang Seng Index: Rose 1,503.2 points or 7.9%, to 20,632

Ø  Hang Seng China Enterprises Index: Rose 534.3 points or 7.9%, to 7,299.

Ø  Hang Seng Tech Index: Rose 528.8 points or 13.5%, to 4,453.

Ø  Shanghai Composite Index: Rose 2.9%, to 3,087.

Ø  Shenzhen Component Index: Rose 6.7%, to 9,514.

This RRR cut has clearly boosted market confidence, encouraging investors to enter the market and driving stock prices higher. Market participants are attentive to future economic data and policy directions to assess the actual impact of this policy on economic recovery.

3. Currency Fluctuations:

• Yuan Depreciation: In the short term, the Chinese yuan may weaken against other currencies. A lower RRR can increase the money supply, leading to concerns about inflation and currency stability. Investors might anticipate that a looser monetary policy could result in a less attractive currency.

• Impact on Exports: A weaker yuan can benefit Chinese exports by making them cheaper for foreign buyers, which can further support economic growth.

4. Bond Market Reactions:

• Yield Decline: Following an RRR cut, bond yields may fall as investors anticipate lower interest rates. This can lead to increased bond prices, as existing bonds with higher yields become more attractive.

• Credit Risk Perception: The bond market may also reflect changing perceptions of credit risk. A more liquid banking system can enhance confidence, particularly in corporate bonds.

5. Commodity Prices:

• Increased Demand Forecast: Commodities like copper and oil may see price increases due to expectations of higher demand as liquidity enhances economic activity. Investors often interpret RRR cuts as signals that the government is committed to stimulating growth, which can drive commodity prices higher.

Longer-Term Market Implications

1. Sustained Growth Expectations:

• If the market perceives that the RRR cut effectively stimulates economic growth, it may lead to sustained bullish sentiment in equity markets. Investors might become more confident in long-term growth trajectories, influencing investment strategies.

2. Inflation Concerns:

• Should inflationary pressures emerge due to increased liquidity, markets may react with volatility. Rising inflation can lead to speculation about future interest rate hikes, affecting both equity and bond markets.

3. Investor Sentiment:

• The recent RRR cut has significantly boosted investor confidence in Chinese equities, as evidenced by substantial gains across major indices (Hang Seng Index up 3.6%, Hang Seng Tech Index up 5.8%, Shanghai Composite up 2.9%), with the potential for further re-rating due to cheap valuations and low positioning, while future market performance remains contingent on upcoming economic indicators and policy measures, particularly in light of the Fed’s dovish pivot and China’s increased capacity for supportive economic measures.

4. Global Market Influence:

• Given China’s significant role in the global economy, reactions in Chinese markets can influence global investor behavior. A positive market response may lead to increased investment flows into emerging markets, while negative responses could trigger risk aversion and capital outflows.

Key takeways

Short-term impacts

•       Immediate boost to Chinese stock markets

•       Increased activity in investment and business

•       Higher liquidity in the financial system

•       Possible short-term economic growth acceleration    

Long-term impacts:

•       Interest rate stability may be achieved if inflation is controlled

•       Long-term currency stability depend on economic fundamentals and trade balances

•       Possible acceleration of economic restructuring

Key sectors to monitor:

•       Banking & financial services

•       Consumer services

•       Construction

Risks

•        Sustainability of debt-fueled growth

•       Effectiveness of implementation

•       Global economic conditions and geopolitical factors

Highlights of new policies issued from China

1. Cutting the 7-day benchmark reverse repo (7D RR) rate by 20bps

2. Reduce the Reserve Requirement Ratio (RRR) rate by 50bps

3. Reduce the downpayment ratio for second housing and above from 25% to 15%

4. Reduce the interest rate on existing mortgages by approximately 50bps

5. Increasing the PBoC’s participation in the 300 billion RMB refinancing of affordable housing funds from 60% to 100%

6. Allowing major institutional investors (banks/insurance companies) to tap central bank financing for stock purchases

7. Loosening the limit for major commercial banks to invest in the stock market from 4% to 10% of balance sheet

8. Allocation of 150 billion RMB in special purpose CGB issuance from central government to local government to facilitate trade-in programs for businesses and households

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