PBOC Surprises Markets and Triggers EM Profit-Taking
by Win Thin
People’s Bank of China surprised markets with a 25 bp hike in early North American hours, taking the 1-year lending rate to 5.56% and the 1-year deposit rate to 2.5%. This was the first official rate hike since December 2008, though there were several hikes in bank reserve requirements in the interim. There was no accompanying statement explaining the decision, but we note that CPI inflation has risen steadily to 3.5% y/y in August, the highest since October 08. September CPI data is out October 21, and the risk is that it will come in higher than the 3.6% y/y rate that the market is expecting, and that the real sector data (Q3 GDP, retail sales, IP, fixed asset investment) comes in stronger than what the authorities would like. This is clearly not a one and done move, and further rate hikes will be seen. We note that the deposit rate remains negative in real terms, and may be encouraging less saving and more consumption that is feeding into price pressures. As an aside, the 25 bp hike is a shift from the usual multiples of 9 (18 bp, 27, bp, etc.) that we have seen from the PBOC.
CNY forwards have softened, with 12-month NDF pricing in about 3% appreciation vs. almost 4% yesterday. Market seems to be thinking that PBOC rate hikes will take some of the pressure off of the authorities to use a firmer currency to fight inflation and slow the economy. Our view is that it is not an either/or, but that China policy-makers will use both tools to manage their economy. Clearly, they are worried about strong growth and inflation and so we look for a combination of official rate hikes and CNY strength going forward and would think about using this selloff to get into long CNY positions at better levels. This rate hike (and others that are likely to follow) will likely fan fears of a hard landing in China, but we believe that the authorities are well-equipped to engineer a soft one. So instead of China growing 10-12%, we are likely to see 8-10% over the next year or two.
What are the implications for China and EM? The double whammy of the PBOC rate hike and Brazil’s hike of the IOF tax last night is leading to broad-based profit-taking in EM FX today, with worst performers vs. USD so far being HUF, PLN, ZAR, and BRL (all down 1-2%). The big question is how deep the correction will be. In recent months, any EM corrections have been short and shallow, with buyers emerging on dips to get in at better levels. Because we have not seen any significant corrections since May/June, there is a risk that this one goes a bit deeper. However, we remain bullish on EM and believe that the conditions supporting the asset class internally (strong fundamentals) as well as externally (global liquidity, risk appetite) are still likely to continue well into 2011.