Dollar Gain, EM Pain: More RRR Cuts Expected

Analysts see the PBoC's expansion of MLF collateral as dealing with a short-term maturity crunch with 500 billion yuan reverse repos maturing this week alone, and another 260 billion maturing in the rest of June. It is believed there was insufficient capital prior to the PBoC rule change. The MLF move doesn't shift monetary policy expectations and expectations of increased MLF are rising, while the expectations of another RRR cut are cooling. Nevertheless, some analysts think more RRR cuts are coming.

21st Century: 央行给MLF担保品扩围并非宽松 年内降准空间仍存 或增加4000亿至6000亿可质押债券规模
There are three types of newly incorporated MLF collateral: not less than AA grade small and micro enterprises, green and "three rural" financial bonds, AA +, AA grade company credit bonds, high quality micro and small corporate loans and green loans.

Pan Xiangdong, chief economist of New Era Securities, believes that the central bank's expansion of the scope of MLF collateral on June 1 may imply that the central bank will continue pursuing MLF in June. Based on this, the current market decline is expected to cool, but many respondents believe that the future trend is still a major trend.

"Replacement of MLF through RRR cuts is still more necessary. On the one hand, it can reduce the financial costs of financial institutions, and on the other hand it can lead to a reduction in the cost of physical financing," said Wen Bin, chief researcher at Minsheng Bank. The current one-year MLF interest rate is 3.3%, while the one-year deposit reserve interest rate is 1.62%.

It is worth emphasizing that expansion of collateral does not mean loosening. Shao Yu, chief economist of Orient Securities, believes that whether or not the easing depends on how many MLFs the central bank gives, after collateral expansion, the amount of reserve collateral increases, and the total amount of MLF that can be acquired increases. However, the number of MLFs eventually released remains to be seen. "This is a necessary condition for loose monetary policy, but it is not a sufficient condition."
Growing concerns about small and medium enterprise defaults show the market thinks policy is a little too tight. The PBoC seems to agree with this latest move on MLF.
Analysts said that the expansion of the MLF collateral helps to meet the pressure of MLF expiry in June and alleviate the problem of insufficient collateral for the renewal of the contract. Wind statistics show that there are 500 billion reverse repurchases in the open market this week (4th - 8th), and there are 259.5bn MLF due on the 6th.

Based on this, expectations of an MLF sequel are expected to heat up, while RRR cut expectations cool. Shenwan Hongyuan analysis says whether the next move is MLF or an RRR cut will be based on the specific circumstances at the time. Comparatively speaking, the MLF sequel contributes more to the replenishment of the base money gap and avoids misjudgment of monetary policy, while an RRR cut improves the structural pressure on the financial sector and financial institutions and guides the funds to support finance.
An RRR cut will still be necessary if the bank doesn't increase MLF enough:
Shao Yu told reporters in the 21st Century Business Herald that whether or not to lower the number of MLFs depends on how much MLF is released by the central bank. If it is less, it is still necessary to lower the standard. “The approach that may be adopted in the future is to reduce the MLF replacement, which is the growth of the currency multiplier. The replacement of the MLF is to reduce the base currency, and ultimately reflects whether there is a change in the growth rate of M2. The tight monetary policy depends on the ratio of M2 and nominal GDP.”

Even Lian Ping said that it is still necessary to cut the RRR. The data shows that the gap between the growth rate of deposits and loans has increased to about 4 percentage points in recent months, and the growth rate of deposits has been significantly slower than that of loans. M2 operates at a low level, and the scale of social financing in the first quarter has grown negatively; while the demand for real economy credit is still small, non-credit financing has obviously contracted. In the current state of basic balance of foreign exchange payments, it is a more appropriate method to provide liquidity through orientation and reduction, and it can also effectively increase the bank's long-term available funds.
Yet if banks don't want to lend, even an RRR cut won't have a large impact in the market. Which is why ultimately, the government may step in and initiate a fourth round of stimulus.
“Although the reserve ratio has been lowered earlier, the current level is still high at 16%. There is little possibility that the reserve ratio will fall sharply this year. I think it may be reduced by 1-2%.” Lian Ping said.
What would that mean for the U.S. dollar? The PBoC announced a 1 percentage point drop in the RRR on April 16. The result was a 6.7 percent rally in the U.S. Dollar Index (DXY). There's good reason to think further RRR cuts could have a bigger impact on the market because a large segment of dollar bears think the current rally is a counter-trend move. Furthermore, emerging markets are already under severe stress from this "counter-trend" move, but if two RRR cuts have a similar impact on the market, it could carry DXY to a new cycle high.
A governor at the Indian central bank penned this article in FT yesterday: Emerging markets face a dollar double whammy
Central Banking: Trigger for emerging market sell-off still playing out, warns Argentine governor

Wall Street is split at the moment.

CNBC: There’s nothing stopping the dollar now, HSBC’s chief currency strategist says
WSJ: Why the Dollar Rally’s End Could Be Near

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