China – back to policy easing?

China looked to be on tightening cycle but the latest activity gauges (especially services) were weak enough for the State Council to suggest lowering the reserve requirements for banks and freeing more credit via this channel. It remains to be seen whether this recommendation will be accepted (the previous one was not) – but there are good reasons to believe that the “no sharp policy turns” approach should hold in either direction. The market currently prices in about 50 basis points of rate hikes in China over the next 12 months (including 36 basis points in 6 months), which now might look excessive. Shorter-duration government bonds can benefit from downward adjustment in expectations. 

China’s contemplating a step back on the policy front - while several other emerging markets (EM) are busy hiking - is actually in line with the EM policy divergence narrative, which we discussed yesterday. The pace of vaccinations is a major differentiator here, so a lot will depend on countries’ ability to prop up the recovery (without completely destroying key macroeconomic metrics). China’s pandemic-related support was sizable, but the overall package was smaller (as a percentage of GDP) than in major developed markets (DM). So, arguably, there is room to do more – especially on a targeted basis.

The two-track post-pandemic recovery and divergence will be among the issues discussed at the gathering of G20 finance ministers and central bank governors in Venice this week. In its latest blog, the IMF noted that “a deepening divergence in economic fortunes” requires urgent action to prevent more countries from falling behind. Vaccine-sharing is one such initiative – the IMF’s US$50 billion plan to deal with this issue is worth noting. The IMF also said that they are exploring new facilities, including a “vaccine window” facility to support the financing of vaccination programs in lower-income countries and a Resilience and Sustainability Fund. Finally, the IMF once again mentioned that lower-income countries with unsustainable debt burdens “should also seek early action for debt resolution” – so we’re keep our eyes open.