There’s no longer any doubt that the People’s Bank of China is tightening monetary policy.
The daily fixing for the 7-day repo rate, the benchmark for banks’ cost of funds, has come in around 3.5% during the past few days, compared with around 2.5% during most of 2020.
In addition to guiding interest rates higher, the Chinese authorities have ordered banks to increase their capital ratios and restrict lending and have shut down a lot of online loan-sharking (for example high-interest loans to students) that masqueraded as fintech.
Chinese regulators also are riding herd on free-spending municipalities that have issued enormous amounts of bonds backed by local government financing vehicles.
China, in short, is fixing its roof while the sun is shining. With the IMF forecasting 8.4% growth for China during 2021 and the most recent purchasing managers’ surveys showing rapid expansion in the services sector, China can afford to de-lever.
Fiscal and monetary stimulus kept China out of the great recession of 2008-2009 and helped China snap back from the Covid-19 contraction of early 2020, but the debt buildup can’t go on forever. The United States meanwhile continues to increase debt at an unprecedented pace.
That creates a conundrum in capital markets. The S&P 500 returned 9% during the year to date while the Shanghai Composite Index returned just 2%. Equity markets like cheap money, in part because it keeps investors out of low (or negative) yields in the bond market, and in part because it allows corporations to gear up and increase earnings per share, at least in the short run.
The question Wall Street strategists are debating is: How long can cheap money levitate the US stock market? Goldman Sachs now says the S&P just might have another 5% of upside during 2021. The prospects for a nasty reversal are high if economic data disappoint.
China, as William Pesek put it March 26, gritted its teeth and took the pain of tightening. China is particularly worried about global hot money flows; if the US Treasury runs into trouble financing its monster deficit, the result could be a global liquidity crunch with hot money outflows from China.
So the Chinese authorities are doing the responsible thing, while America continues to run up its plastic. For the long-term investor, Asian (especially Chinese and Japanese) stocks are reasonably priced and positioned to benefit from sustained growth. If you’re looking for a short-term score, though, Shanghai isn’t the place to find it this month.