PBOC could be shifting to more accommodative policy
PBOC could be shifting to more accommodative policy
The FOMC released its minutes from the January 28th/29th meeting last week, and as expected, coronavirus is not a needle mover at this point. While the virus has been added to the Fed’s list of risks to the global growth outlook, it warrants “close watching” rather than an immediate policy response. In other words, don’t expect another “insurance cut” like we saw in 2019. Any policy response to the coronavirus threat we’d see will likely be reactive rather than proactive.
While the Fed pursues its “wait and see” approach, The People’s Bank of China (PBOC), unfortunately, does not have the same luxury. On February 20th, the PBOC cut its benchmark 1-year Loan Prime Rate (LPR) by 10bps and its 5-year LPR target by 5bps.
On one hand, these cuts are nominal. Can a 5bps -10bps rate cut really provide much stimulus to the Chinese economy over the short term? I don’t think so. On the other hand, when taken in conjunction with the PBOC’s $170bn liquidity injection on Feb 2nd, these cuts could represent a shift towards more accommodative policy by the PBOC, one of the only major central banks with substantial room for further cuts.
On the balance sheet front, the minutes noted that the Fed’s treasury bill purchases will continue to the tune of $60bn per month until at least the start of Q2. Estimates suggest that after April 2020, the purchases will have restored the permanent base of reserves to September 2019 levels. If history provides any insight, expect the Fed to tread lightly when scaling back these purchases. Here are two main reasons why:
First, the 2013 “Taper Tantrum” clearly demonstrated that putting assets up on the Fed balance sheet is much easier than taking them off; both from a market and political standpoint. The 2013 Tantrum commenced in earnest when former Fed Chairman, Ben Bernanke, mentioned that the Fed could begin scaling back asset purchases in May 2013. It wasn’t until 5 meetings later, in December 2013, that the Fed a began scaling back monthly asset purchases ever so slightly from $85 billion to $75 billion per month.
Second, the Fed essentially got it wrong in 2018. Of the four rate hikes executed in 2018, three were quickly unwound in 2019. If the Fed prematurely halts asset purchases, they run the risk of “making the same mistake twice”. Legacy does matter when it comes to making policy decisions, and Fed officials would be wise to carefully assess the impact of halting purchases.
The CME Fed futures market, historically a good indicator of rate trends, puts a 10% rate change probability (reduction) in March. The U.S. Treasury 10-yr note yield was around 1.47%, down from 1.58% last week.
Upcoming: 3/17-18 - FOMC meeting. No action expected.
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