Forecasters are increasingly describing clear skies ahead for the global economy and markets in 2014. But are investors wise to ignore potential storm clouds gathering in the East, where China’s huge banking system is undergoing a fresh cash crunch?
Overnight benchmark lending rates among Chinese banks rose to 8.94% Monday from 8.21% Friday. Not far below the 2014 highs of 9.29% reached in June, when a broader emerging-markets capital-flight scare was underway following early hints that the Federal Reserve was preparing to curtail its quantitative-easing asset-buying pace. The Fed of course did set a reduction in QE last week, yet for now global markets are taking it in stride.
As discussed in the attached video, there are a few reasons Western markets have not been roiled by the latest Chinese bank-funding stresses:
The People’s Bank of China is perceived to have a handle on the situation, treating the spike in funding costs as a temporary scramble for cash by banks seeking to meet year-end capital needs. The central bank has provided only limited cash injections, while pointing out that the system as a whole has ample reserves.
As always when it comes to China, investors assume a great deal of control to the authorities, suggesting that the central bank could supply all needed cash if it so chose, as it ultimately did in the summer. Back then markets feared the PBoC was actively looking to “bleed the patient” in a painful way by forcing some weaker lenders out of business. Today investors are less jittery about this prospect. Michael Block, strategist at Rhino trading, addressed this common view in comments to clients this morning:
“I have said before that there has to be a method to the PBoC’s madness. Are they shaking out money launderers, perhaps chunky ones with funny haircuts in Pyongyang? Is there some massive manipulation game going on, some risk-laden arbitrage that is benefiting someone in Beijing? Or are these just growing pains as the monetary system goes through some evolutionary process? Perhaps it’s a bit of everything I described. I have said before that I do believe that Beijing has a good handle on its banking system. Consider me a bit more skeptical given these latest episodes.”
The Chinese currency has been rising and capital is flowing into the country, providing a certain level of comfort. This suggests no broader capital flight that would badly destabilize the system, thus freeing U.S. markets to calmly drift to yet more new highs Monday morning - correct or not.
The broader emerging-country capital markets are not showing significant “taper”-related fright. In the spring currencies of India, Turkey and Brazil were in steep decline, whereas they have been fairly steady of late. This too allays fears of a nasty chain reaction being set off.
The global growth picture is perceived to be clearer today than six months ago, given brisker U.S. growth, less concern about a Chinese “hard landing” and signs of life in Europe.
Chinese stocks, notably, just barely ended a nine-session losing streak and are trading near a four-month low. This is both a nagging exception to the happy global-risk market story and a potential opportunity for long-term investors. Emerging markets are the one large chunk of global equities that appear relatively cheap and out-of-favor – often a recipe for superior returns to come.
Yet there’s no way to rule out some sort of “financial accident” that would upend the positive investor feelings globally. Prolonged periods of cheap money tend to lay the groundwork for capital-market excesses, and it’s unclear how world markets will adjust to the tidal change in Fed policy and expected upward tilt in interest rates.
Disaster has a way of not happening, perhaps, but with so much else pointing in a positive direction as we enter 2014, it probably makes sense to keep one eye on the colicky money markets of China to see whether this is yet another false alarm for this powerful bull market in risk assets.
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