- PBOC limits interest rate cuts in order to support the yuan and prevent new debt binge
- U.S. LEI expected to rebound higher
- 30-year TIPS auction to yield near 0.29%
PBOC limits interest rate cuts in order to support the yuan and prevent new debt binge — China’s 1-year loan prime rate (LPR), the reference rate for corporate and household loans, was cut last night by -10 bp to 4.05% at its monthly fixing, which was in line with market expectations.
The decline in the LPR reference rate was the result of the move by the People’s Bank of China (PBOC) to cut interest rates by -10 bp on recent bank loans and repo operations. The PBOC on Feb 3 cut its reverse repo rates by -10 bp, with the 7-year reverse repo rate dropping to 2.40% and the 14-day reverse repo rate to 2.55%. The PBOC this past Monday cut its 1-year medium-term loan rate by -10 bp to 3.15%, the lowest rate since 2017.
The PBOC is cutting rates slowly as it assesses the extent of the damage from the coronavirus. In addition, the PBOC does not want to cut interest rates too sharply since that could cause a sharp drop in the Chinese yuan, which in turn could spark heavy capital flight and a sharp drop in stocks. Investor confidence is currently very fragile and it might not take much to spark a run on the Chinese yuan and Chinese stocks. The PBOC also does not want to cut rates too sharply and cause a new debt binge that it must clean up later.
The Chinese yuan fell sharply in the second half of January to a 2-month low of 7.0256 yuan/USD. However, the yuan has since rebounded mildly higher and is currently down by only -0.5% year-to-date. The PBOC has so far done a good job of supporting the yuan and preventing a run.
Meanwhile, the Shanghai Composite index has shown a remarkable recovery in the past two weeks despite the major economic damage that is being caused by the coronavirus. The Shanghai Composite initially plunged on the coronavirus by an overall -16.4% from the mid-January 10-month high to the early-Feb 1-year low. However, the Shanghai Composite index has since rebounded by +10.8% from that low and is currently down by only -2.4% year-to-date.
The shutdown of the majority of China’s economy for the last three weeks has taken a heavy toll on China’s economic outlook. The consensus is now for Q1 Chinese GDP growth of only +4.0%, down from the pre-virus consensus of +5.9%, according to Bloomberg News. The consensus for China’s calendar year growth in 2020 has fallen to +5.5% from +5.9%.
The markets are hoping that the Chinese economy will see a so-called “V” shaped recovery where the steep decline will be followed by an equally steep recovery. However, the recovery cannot really even begin until the Chinese government declares that the coronavirus is contained and gives the all-clear for the Chinese economy to fully resume business operations and travel. The recovery is therefore likely to be slow and halting.
The Chinese financial markets are particularly on guard for corporate bond defaults, which were already running at record levels before the coronavirus emerged. Moreover, consumer spending is taking a heavy hit as many employees are not even being paid during the business shutdowns, which will cause a heavy hit to consumer spending in Q1.
U.S. LEI expected to rebound higher — The market consensus is for today’s Jan leading indicators index to show a rise of +0.4% m/m and +0.5%, rebounding higher from Dec’s weak report of -0.3% m/m and +0.1% y/y. If the LEI today shows the expected increase of +0.5% on a year-on-year basis, then the series will avoid falling into negative year-on-year territory. The LEI in December fell to a 10-year low of +0.1% y/y and narrowly avoided turning negative for the first time since late 2009 when the Great Recession was just ending.
While the LEI today is expected to show a solid increase of +0.4% in January, the LEI is likely to show weakness again in February as the negative impact fully emerges from the coronavirus. The consensus is that the coronavirus will knock 0.2-0.4 percentage points off U.S. GDP.
The current consensus is for U.S. GDP to dip to +1.5% in Q1 and then return to long-term potential at +1.9-2.0% in the last three quarters of 2020. On a calendar year basis, the consensus is for GDP to decelerate to +1.8% in 2020 from +2.3% in 2019 and +2.9% in 2018. However, GDP is then expected to improve slightly to +2.0% in 2021 and +1.9% in 2022.
30-year TIPS auction to yield near 0.29% — The Treasury today will auction $8 billion of 30-year TIPS. The Treasury last year conducted only two 30-year TIPS auction, selling a new 30-year TIPS in February 2018 and then conducting one reopening in August.
The 30-year TIPS yield so far this year has fallen along with the rest of the Treasury curve due to the coronavirus. The benchmark 30-year TIPS yield yesterday closed at 0.29%, which is just 4 bp above the early-Feb 7-1/4 year low of 0.25%. The new 30-year TIPS issue late yesterday afternoon was trading near 0.29% in when-issued trading.
The 12-auction averages for the 30-year TIPS are as follows: 2.49 bid cover ratio, $12 million in non-competitive bids, 6.5 bp tail to the median yield, 19.9 bp tail to the low yield, and 58% taken at the high yield. The 30-year TIPS is the most popular coupon security among foreign investors and central banks. Indirect bidders, a proxy for foreign buyers, have taken an average of 75.2% of the last twelve 30-year TIPS auctions, which is far above the median of 60.1% for all recent Treasury coupon auctions.
