Latest On PBOC, ECB And The Fed

The outcome from China’s third Plenary Session suggests the country will prolong the path towards structural reforms. The reform plan covered 15 areas and 60 specific measures.

Two signs emerged from Session, which aimed to deal with the unsustainability of China’s investment and credit- centric growth model. These were: i) increased market-based models for allocating resources, including basic inputs such as financing, agriculture and energy and ultimately doing away with subsidies long enjoyed by large firms; ii) the establishment of a central leadership team on designing, coordinating, advancing and supervising the implementation of reforms.

Financial services and insurance stocks were boosted by announcements of simplifying the financial tax code and further financial reform. Real estate stocks also advanced on the lack of measures aimed at reining in property investments.

On the foreign exchange front, the Session reiterated the People’s Bank of China’s usual line of accelerating yuan convertibility and liberalization of interest. PBOC governor Zhou Xiaochuan said the central bank will “basically” end normal intervention in the currency market and the yuan’s trading band will be widened in an “orderly way” as China enhances the CNY’s two-way flexibility. Investment caps for domestic and foreign investors will be phased out and the ceiling on deposit rates offered by local banks will be gradually removed.

Other notable announcements hinted at fiscal reforms to establish clearer income and spending channels between local and central governments. Providing greater property rights to farmers as part of land reforms to promote urbanization has also been part of the agenda.

More clarity as far as schedule is anticipated at the National People’s Congress in March.

ECB & Fed Combined Euro Strike

Yesterday’s ECB chatter about negative deposit rates along with a hawkish bent in the latest FOMC minutes led to 100-pip drop in EUR/USD, shortly after having hit 2-week highs. A Bloomberg report indicating the ECB is considering dropping its deposit rate to -0.10% once policymakers justify launching more stimulus to fight off disinflation.

The second catalyst to Euro’s damage emerged following the release of the October FOMC minutes. While there was no smoking gun in the minutes, traders zoomed in on signs of loosening the forward guidance in the form of lowering the unemployment threshold to 5.5% From 6.5% but the minutes said only ‘a couple’ members would support such a move.

If we had learned anything from the Fed impact on market over the last 5 months, is that FOMC minutes have sounded more hawkish than FOMC statements as these have usually contained a downgrade of economic conditions, while the minutes show detailed discussions, which shed more light on hawkish members’ rationale.

We continue to anticipate the Fed will pay more attention to the risks of disinflation and the possibility of setting a floor to inflation, rather than lower in the 6.5% unemployment rate threshold. EURUSD is likely to retest 1.3370s before drawing afresh attempt towards 1.3660s nearing mid December.

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