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China's Market News: PBOC: Signs of a Liquidity Trap Emerge in China

China's Market News: PBOC: Signs of a Liquidity Trap Emerge in China

Renee Mu, Currency Analyst

This daily digest focuses on market sentiment, new developments in China’s foreign exchange policy, changes in financial market regulations and Chinese-language economic coverage in order to keep DailyFX readers up-to-date on news typically covered only in Chinese-language sources.

- Market participants are watching the PBOC’s daily fix tomorrow after the Yuan’s major breakout.

- PBOC official addresses the increasing risk of a liquidity trap and commented on monetary policy.

- Shanghai Stock Exchange introduces new rules on closing prices thanks to the trading link with more developed markets.

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Hexun News: Chinese leading online media of financial news.

- The onshore Yuan (USD/CNY) broke the key resistance level of 6.70 on Monday for the first time since November 2010. The offshore Yuan (USD/CNH) broke the same key level last Friday. On Monday, the PBOC set the daily fix in the Dollar/Yuan rate 156-pips weaker to 6.6961, the lowest level in five-and-half years. The level of 6.70 carries with it psycho-social importance. Chinese financial institutions expected that the PBOC would intervene and hold Yuan rates around this level for a while in the effort of slowing down the pace of Yuan devaluation against the US Dollar. However, if the PBOC wants to maintain its current Yuan exchange rate regime, it needs to allow the Yuan to follow market moves. The daily fix to be set by the PBOC tomorrow will signal whether such breakout is recognized by the regulator and thus worth keeping an eye on.

- The CFETS Yuan Index was reported at 94.38 on July 15th, rising +0.13% from a week ago. This is the first increase in the Yuan index since May 20th. The other two Yuan Indexes, BIS Yuan Index and SDR Yuan Index continued to drop over the past week, falling -0.10% and -0.05% to 95.33 and 95.37 respectively. Over the same period, the offshore Yuan (USD/CNH) lost -0.13% while the onshore Yuan (USD/CNY) increased +0.09%. The Central Bank is targeting Yuan stability against the currency basket, which is mainly measured by the CFETS Yuan Index.

Under the current condition, the PBOC is neither likely to revise the Yuan’s exchange rate regime nor the Yuan stability target, as such changes could cause market worries and chaos, which goes against China’s major goal of financial stability. The Central Bank is neither likely to hold the Yuan rate at any specific level forever, as it needs to burn foreign reserves which have already seen sharp drops this year. Yet, slowing down the pace of Yuan depreciation matters to China as plunges lower may not only lead to Yuan short speculation in offshore markets again, but could trigger panic exchanges in foreign currencies onshore (Chinese individuals are allowed to exchange $50,000 or equivalent of other currency per year). Thus, the timing of the Yuan breakout is under close watch by the regulator.

China Finance Information: a finance online media administrated by Xinhua Agency.

- China’s Central Bank issued 227 billion Yuan of Medium-term Lending Facility (MLF) to 14 target banks on July 18th, the ninth MLF this year. The package includes 53 billion Yuan of 3-month MLF, 134.5 billion Yuan of 6-month and 39.5 billion Yuan of 1-year MLF. The net liquidity added on the day through 7-day reverse repos was 20 billion Yuan. With these continued MLF and reverse repos injection as substitutions, the likelihood of PBOC cutting rates in the near future continues to drop.

In addition, the Director of Survey and Statistics Department of the PBOC, Sheng Songcheng, said on July 16th that China has showed signs of ‘a liquidity trap’. A liquidity trap is a situation in which a central bank fails to decrease interest rates with expansive monetary policy and fails to stimulate the economy. Director Sheng pointed out that the increasing gap seen between M1 and M2 indicates that companies are lacking investment opportunities and have left a huge amount of money in demand deposits. The gap between M1 and M2 started to widen last October. The most recent data shows that the M2 growth in June was 11.8% while the M1 growth soared to 24.6%. This means there are approximate 38 trillion Yuan in cash left in demand deposits. Therefore, Director Sheng said that China needs to use both monetary policy and fiscal policy in the effort of stimulating the economy. China may increase the fiscal deficit ratio to as high as 4% to 5% if necessary over the following periods.

Sina News: China’s most important online media source, similar to CNN in the US. They also own a Chinese version of Twitter, called Weibo, with around 200 million active users monthly.

- SAFE, China’s FX regulator, approved the first group of foreign exchange swap reversals in China’s interbank market. This shows that China continues to make progress in developing the domestic FX market by providing more FX products. 15 Chinese and international financial institutions participated in the swap reversal program and offset a total amount of $3.48 billion foreign exchange swaps based on their needs.

- The Shanghai Stock Exchange will adopt new rules effective on July 25th on closing prices for equities included in the trading link between Shanghai and Hong Kong stock exchanges. The Hong Kong Stock Exchange will introduce a closing auction session that has been widely used in many developed countries on July 25th, which may better meet the high institutional demand for execution at the closing price. Because of the trading link between Hong Kong and mainland China through the Shanghai-Hong Kong Stock Connect, the Shanghai Stock Exchange introduced news rules accordingly. This shows that capital flow channels in China not only facilitates investment to and from China but also provide external forces to help continue reforming China’s equity market in order to let it reach the global standard.

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DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.