news

"This rate cut is a key step towards price-based regulation reform and the establishment of a modern central bank system."

Text/ Ba Jiuling

Typhoon Gemi has made landfall, and in the face of the impending storm and lightning, the central bank has also cut interest rates beyond expectations.

First, on July 22, three days ago, the central bank announced a 10 basis point cut in the LPR, with the 1-year and 5-year LPRs falling to 3.35% and 3.85% respectively, and then adjusted the 7-day reverse repo rate from 1.8% to 1.7%. Yesterday, on July 25, the central bank cut the medium-term lending facility (MLF) by 20 basis points.

At the same time, the five major state-owned banks -Bank of China、ICBC、ABC、Bank of Communications、China Construction BankCollectively reduce deposit rates. This is the first interest rate cut in 2024 and the fifth since the establishment of the deposit rate market-oriented adjustment mechanism in April 2022. Among the adjusted interest rates, the annual interest rate for five-year fixed deposits was reduced by 20 basis points from the previous 2% to 1.8%, and the one-year deposit rate was also reduced by 10 basis points to 1.35%.

The deposit interest rate fell below 2% for the first time, which was an inevitable move for banks.

Because throughout 2023, the deposits of 21 A-share banks increased by more than 17 trillion yuan, and the deposit scale growth rate of ICBC, ABC and CCB all exceeded 10%. In the first half of 2024, the new deposits exceeded 9 trillion yuan.

However, household loans increased by only 1.46 trillion yuan in the first half of the year, almost halved year-on-year. Banks can't bear the sharp increase in deposits and the sharp drop in loans. Now the net interest margin has dropped to 1.5%, below the warning line of 1.8%. Only by continuously lowering interest rates can banks resolve the crisis.

But ordinary people may not be happy. With employment and income expectations uncertain, people tend to invest in low-risk assets, and the ratio of time deposits to demand deposits has changed from "60% to 40%" in 2017 to "70% to 30%" today. In the past year or so, ordinary people have tried every possible means to get that little bit of "humble" interest (life-saving money).

Some people have started the "special forces" mode. They have set their sights on the interest rate spread between large state-owned banks and small local banks. They have run from one city to another, moving deposits, and even shuttling between high-interest village banks. Some people have actively "gone global" and invested their money in Hong Kong stocks, or made global asset allocations in Europe, the United States, India, and Southeast Asia by purchasing QDII funds and other means.

Those who have no way to "go out" can invest in long-term government bonds, causing a sharp drop in government bond yields, or purchase financial management insurance that locks in interest rates.

There is also a disguised form of financial management - paying off mortgages in advance. This is why the increase in residents' deposits this year is 2 trillion yuan less than last year.

Today, deposit interest rates have historically slipped into the "1-digit" era. According to the rule that "large state-owned banks take the lead in adjustment, joint-stock banks quickly follow up, and small and medium-sized banks gradually follow up", as well as the logic of continuing to ease the pressure on banks' net interest margins, interest rates will likely continue to decline in the future - at that time, the financial management special forces will collectively "break the defense."

The purpose of interest rate cuts is to boost confidence and raise asset prices. In fact, as long as one of the housing and stock markets starts to improve, the expectations and confidence of ordinary people will rise. However, although interest rate cuts can release funds into the capital market, which is a good expectation, the A-shares have been a bit "unsatisfactory" in the past two days. Yesterday, the Shanghai Composite Index fell below 2,900 points again...

This is the micro level of interest rate cuts.

However, from a macro perspective, the interest rate cuts in the past two days have certain historical significance.

We know that China's interest rate transmission path is "central bank-policy interest rate-market benchmark interest rate-market interest rate". The previous policy interest rate was MLF, which affected the deposit interest rate by affecting the LPR on the monetary side and the 10-year treasury bond interest rate on the bond side. Now it has become the 7-day reverse repurchase rate (OMO), which confirms the previous statement by Pan Gongsheng, the governor of the central bank,LujiazuiSpeech at the forum.

The 7-day reverse repo rate refers to the central bank buying securities from banks and giving money to banks, which becomes the bank's funding cost, which is equivalent to the central bank injecting money into the market in the short term. When the 7 days are up, the bank returns the money and the interest for the 7 days to the central bank, and this interest is the 7-day reverse repo rate.

OMO not only reflects the short-term market demand for funds, but also directly reflects the central bank's regulatory intentions. It is updated daily, which means that it can send signals of interest rate cuts or hikes every day. As for the interest rate cut on July 22, the announcement said that OMO would be changed from the original bidding to "fixed interest rate, quantity bidding", announcing the interest rate change in advance.

Therefore, domestic and foreign economists regard the reduction in LPR and deposit rates as the "debut" of the new interest rate framework.

Xue Qinghe, president of Zhibenshe, believes that "last week, the central bank first lowered the seven-day reverse repurchase rate by 10 basis points, followed by a 10 basis point reduction in the LPR, marking a shift in China's monetary policy focus from the MLF to the seven-day reverse repurchase rate, the decoupling of the LPR from the MLF, and the beginning of anchoring short-term interest rates, a key step towards price-based regulation reform and the establishment of a modern central bank system."

From the perspective of global competition, interest rate cuts are even more important.

Since the outbreak, China has been in the process of lowering interest rates, while the United States is in a cycle of raising interest rates, resulting in an inverted interest rate. An emerging country that should have high returns has low interest rates for a long time, and capital will naturally flow out. However, since the beginning of this year, as US inflation has fallen beyond expectations, the Federal Reserve is considering cutting interest rates, but has been slow to make up its mind.

But a dramatic scene still happened: Trump survived the assassin's gun, greatly increasing his chances of being elected president. By then, the Fed's interest rate cut was basically a foregone conclusion. Trump came from industrial capital and favored free competition and interest rate cuts to stimulate the economy. He could devalue the dollar through monetary easing and encourage industrial repatriation. He once publicly warned that if the Fed did not cut interest rates before the election, he would not fire the current Fed Chairman Powell after taking office.

The Fed’s interest rate cut means that the interest rate inversion between China and the United States will narrow, and China will have greater room for monetary policy.

What does this mean? The initiative will be in China's hands. We can choose to continue to cut interest rates, thus entering a liquidity easing cycle. Extremely low interest rates will be good for the real economy, stock market, and bond market. Because the US cuts interest rates, the RMB will appreciate relatively, and if China follows suit, the RMB may even depreciate.

In the view of financial commentator Liu Xiaobo, depreciation is not a bad thing. It will help enhance the competitiveness of Chinese products and reduce travel costs for foreign friends, especially the high-net-worth group who tend to move their funds overseas, as their funds may be "discounted".

Therefore, under the background of low interest rates, funds will probably be invested in "new quality productivity".

Let's briefly explain the background first. The subsequent questions are: Will interest rates continue to fall in the future? What is the impact of interest rate cuts on the macro economy and investment? What investment strategies do ordinary people have at this stage? We will leave these professional questions to economists.

Big Head has something to say

▶▷First, this rate cut was not unexpected.

◎ First, nominal GDP fell below 4% in the second quarter, and nominal GDP has been lower than real GDP for five consecutive quarters, reflecting insufficient demand and low inflation. If the nominal GDP growth rate continues to decline, it will easily push up debt risks.

◎ Second, in terms of financial indicators, the year-on-year growth rate of M2 continued to decline in June, and the year-on-year decline of M1 further expanded, reflecting a decline in market liquidity and capital activity.

◎ Third, the inflation index, PPI and CPI continued to be relatively sluggish, and the task of boosting inflation became more difficult.

◎ Fourth, the decline in real estate investment, financing and sales has narrowed, but there is still some distance to go before stopping the decline and stabilizing.

◎ Fifth, after the conference, it is necessary to release positive signals and boost market confidence by lowering interest rates.

▶▷Secondly, from the perspective of the central bank’s monetary policy reform, this interest rate cut is of historic and symbolic significance.

Last week, the central bank first lowered the seven-day reverse repurchase rate by 10 basis points, and then lowered the LPR by 10 basis points. This marked the shift of China's monetary policy focus from MLF to the seven-day reverse repurchase rate. The LPR was decoupled from the MLF and began to anchor short-term interest rates. This was a key step towards price-based regulation reform and the establishment of a modern central bank system.

▶▷Third, why did the MLF rate drop by 20BP on July 25, and why was it an unconventional move to open an additional MLF operation window 15 days later?

The reason is: since the beginning of this year, the interest rate of treasury bonds has continued to decline, which has depressed the medium- and long-term interest rates in the market. In addition, the seven-day reverse repurchase rate this week pushed down the LPR, further pushing down the medium- and long-term interest rates in the market. As the central bank's medium- and long-term policy interest rate, MLF needs to follow the natural interest rate and the new short-term policy interest rate. This shows that the seven-day reverse repurchase rate is becoming the new policy interest rate, and MLF is just a follow-up operation. Therefore, the MLF has fallen by a large margin this time, and it is an increase in operations.

▶▷Fourth, although the seven-day reverse repurchase rate and LPR both fell by 10BP, and the MLF was lowered by 20BP, the decline was the largest since April 2020, but this cannot be understood as excessive easing, but only moderate easing.

The reason is: the current nominal economic growth rate is declining, demand is insufficient, and inflation is low; due to the continued low inflation, the real interest rate continues to rise and remains at a high historical level, which is likely to suppress investment and consumption, increase debt repayment burden and financing costs. Based on the current nominal growth rate and inflation situation, it is recommended to further significantly cut interest rates.

▶▷Fifth, the central bank’s interest rate cut directly prompted the six major banks and commercial banks to lower deposit interest rates.

The reason is: in recent years, as the central bank has steadily lowered interest rates, pushing down loan interest rates, the net interest margin of commercial banks has continued to shrink. In the first half of this year, the net interest margin of the six major banks fell to 1.5-1.6%, which is lower than the agreed net interest margin of 1.8%. This week, the central bank cut interest rates again, and commercial banks chose to simultaneously lower deposit rates to reduce interest payment costs and pressure on the liability side, and to protect net interest margins and profits.

This "interest rate cut" easing came faster than expected.

Although the central bank has some intention of "tightening" in the second quarter, it is only a matter of time before interest rates are cut and loosened. The core logic is that we are still in a cycle of weak economic recovery, and the lack of effective domestic demand is still the most urgent problem to be solved. Even if the interest rate cut will put some pressure on the RMB exchange rate, the current domestic economic goals must still be the core, and the necessity of loosening has increased.

But in terms of timing, it is a little earlier than we thought.

Because the central bank was sending out a signal of "warning tightening" through a series of measures such as selling bonds. The main goal is to prevent the financial risks of the previous currency idleness. Because the previous monetary easing was relatively large, a large amount of funds were deposited in the financial system. For example, a large amount of bank funds poured into the bond market, especially the long-term bond market. The long-term interest rate was unprecedentedly low. The central bank repeatedly warned of risks, but institutions still bought, so the central bank also wanted to force financial institutions to control risks through tightening.

So we can see that the MLF of the central bank on the 15th of this month did not actually cut interest rates. Generally speaking, if the MLF does not cut interest rates on the 15th, the LPR will not be cut later, but surprisingly, this time the LPR was cut first, and then the MLF was temporarily increased, and the interest rate was cut simultaneously. In form, it was a very special "easing" measure.

Previously, we judged that the current economic foundation does not support tightening. Once tightening, the economy will inevitably fall again, so this warning tightening will not last long, and we should see a return to easing in the late third quarter. Judging from the current situation, this switch is faster than we thought, and a relatively loose signal has been released since July.

Of course, the policy effect will not be reflected immediately, and it will still go through a gradual penetration process in the short term.

In fact, our monetary easing has actually lasted for a long time. It’s just that there is a transmission chain between the policy and the real economy, which is to stimulate everyone to increase leverage through lower interest rates and lower debt costs to support the recovery of economic demand. However, this reaction chain has been very bumpy in the past one or two years, especially in the household sector.

Due to the systematic decline in current demand for housing, the willingness of the household sector to increase leverage is very weak. This weakening of the real estate market and household leverage is not just a simple cyclical phenomenon, but is compounded by medium- and long-term pressures such as an aging population and oversupply.

Although monetary easing can help ease the short-term downward pressure on the real estate sector, it is unable to change the medium- and long-term fundamentals of real estate. Therefore, compared with the past, the effect of this easing is bound to be greatly reduced.

Current policies and changes in economic fundamentals have a certain impact on investment.

▶▷First, in the long run, we still need to lower our expectations for returns, because the downward trend in interest rates is an inevitable trend, and the expected rate of return on investment will decline, whether it is real assets or financial markets.

▶▷Second, the bull market in bonds has not ended in the short term, mainly benefiting from monetary easing and insufficient effective demand. However, in the medium term, the cost-effectiveness has declined significantly. If the economy gradually strengthens, the risks in the bond market will gradually emerge. Relatively speaking, the cost-effectiveness of the stock market will increase accordingly, but this switch will take some time.

The main problem is that the economic recovery is weak, deflation has not ended, and the A-share fundamentals of the corporate earnings cycle have not seen upward momentum. Therefore, although the valuation of A-shares is already very cheap, it is still in the bottoming stage, and the upward trend still needs to wait for the resonance of fundamentals.

▶▷Third, some defensive assets are relatively strong, that is, defensive industries with relatively stable profits and relatively small liquidation pressure. However, offensive industries with high growth and high valuations have not yet achieved performance reversal and still need to be treated with caution.

Weak US macroeconomic data has increased market expectations for a rate cut by the Federal Reserve, causing the US dollar to fall. If US economic data slows steadily, the dollar may weaken across the board. However, the RMB is an exception, as Chinese economic data was also weaker than expected.

In addition, if Trump wins, the RMB will also face downward pressure due to his proposed high tariffs on Chinese goods. According to UBS's forecast, in extreme cases, the RMB exchange rate may rise to 8.0.

As for the main constraints on China's stock market at this stage, one is the lack of confidence among investors, and the other is the weakness of macroeconomic data. For example, GDP growth in the second quarter was lower than expected, and housing prices and consumption data in June were also unsatisfactory.

Therefore, this rate cut is seen as a response to the weaker-than-expected second quarter GDP data, which to some extent indicates that the People's Bank of China continues to have a supportive bias. The recent market expectations for the Fed's September rate cut are getting higher and higher, which may also provide the People's Bank of China with some wiggle room to cut interest rates now.

From an investment perspective, defensive investments such as gold are recommended. If you are looking for sectors in the stock market, high-yield stocks are a safe haven.

Author of this article | Xu Tao | He Feng Yue Ban | responsibilityEditor | He Mengfei

Editor-in-Chief | He Mengfei | Image source |VCG