This current historical period for markets is one of a kind, isn’t it? Surely when it comes to the dissemination of fake and misleading news. This is the set of policy measures the PBOC announced yesterday in support of the Chinese economy:
- Short-term policy rate cut
- Mortgage rate cut
- Banks’ Reserve Requirement Ratio (RRR) cut
- The down payment ratio changed from 25% to 15%
- Renewed support for the CNY 300bn re-lending program local governments can tap to purchase unsold homes
- Set up a CNY 500bn structural monetary policy facility
- Set up a CNY 300bn re-lending facility for banks to support listed company buy-backs and purchases
- The PBOC will gradually start boosting the Tier 1 capital of the 6 largest commercial banks in China.
All the policies above except one were in line with the two principles China is clearly following to reboot its economy and resume sustainable growth (“THE TWO KEY PRINCIPLES UPON WHICH CHINA IS REBOOTING ITS ECONOMY (AND THAT THE WEST DOESN’T UNDERSTAND“), but before we discuss the most important one, allow me to quickly debunk the big fake news that has been timely reported by Bloomberg (“China to Allow Funds, Brokers to Tap PBOC Funding to Buy Stocks“) to trigger a big short squeeze (“Hong Kong Stock Rally Likely Driven by Short Covering, JPM Says“) exactly as it happened back in January (“China Weighs Stock Market Rescue Package Backed by $278 Billion“).
The CNY 500bn (~70bn USD) structural monetary facility set up by the PBOC is a swap line that brokers and financial institutions can access to tap liquidity when purchasing stocks, provided they pledge high-quality assets. Translated, when a broker buys a stock, it needs the money to settle the transaction, right? What happens if they do not have the liquidity to do so? Then there is a failed settlement that creates a series of failures in the market due to the liquidity vacuum to fill. The purpose of this line is to avoid a spike in failed settlements and mitigate the risk of severe disruptions in markets and within the financial system. Being a swap line, it means the money borrowed has to be repaid to the PBOC; consequently, it is a temporary cushion to manage short-term cash imbalances, not capital being injected into banks, brokers, and insurances that can be used to buy proprietary positions in stocks. Furthermore, holding stocks is very capital intensive, but there is flexibility for market-making activities that are exactly the target of the PBOC here. Clearly, this facility is in support of smooth market functionality, but in the grand scheme of things, it is a zero-sum game instead everyone quickly rushed to label this as “the PBOC is giving banks money to buy stocks”. I wonder if the PBOC setting up this facility has anything to do with the BOJ draining ~10 Trillion JPY (~70bn USD) from the market in the past 10-day cycle as shown by the latest BOJ accounts released today (accounts as of 20 September), but we will never be able to know with certainty.
The CNY 300bn (~43bn$) re-lending facility established to support companies’ stock buy-backs and purchases is once again a measure to mitigate the risk of liquidity stress in the system. Why? When a company buys back its stocks or purchases others in the market (for example, to pursue an M&A), the bank holding the deposit of this corporation is going to face a significant outflow of deposits and cash, right? This increases the liquidity stress in the market and the risk of failed settlements if a bank doesn’t have enough cash to settle its client payment instructions resulting from stock buybacks. The cost of this re-lending facility set at 1.75% is actually expensive for banks to access when the short-term policy rate is now set at 1.5%, so clearly those who do that will only borrow from it for the time they need to restore their liquidity balances. The benefit of this is to avoid banks short of cash rushing to dump liquid assets into the market, avoiding unnecessary selling pressure, but as it should be clear now, it doesn’t add any additional demand for stocks in the system since those companies engaging in buybacks and stock purchases will still have to generate profits and cash through their operations first in order to pursue them.
I hope it is now clear how the (fake) news reported about the “PBOC QE Bazooka to pump stocks” was completely, and I believe intentionally, misleading. Bear in mind what we just discussed though, because it is very important for what we are going to talk about next.
The news that should have made big headlines around the world yesterday was instead this one reported by China’s public news agency Xinhua: “China plans to inject capital into six major commercial banks“. Believe me, when I read this, my jaw dropped:
“Li Yunze, head of the National Financial Regulatory Administration, told a press conference that the capital will be injected in an orderly manner, with coordinated advancement, phased implementation and tailored policies.“
This is not a big deal, but a VERY BIG one. Despite troubles in the Chinese real estate markets with large developers like Evergrande or Country Garden going bust in recent years and defaults of small local banks as a consequence of losses incurred on real estate lending, China never injected capital directly into the banking system. Yes, the government arranged consolidation among banks in the system and forced them to implement draconian cost-cutting measures to shore up their capital, but never before had it injected capital into them. So why now? Being very familiar with Chinese culture and thought process, the answer is only one: China knows there is a risk of a big international bank going bust and is moving ahead of time to absorb the shock that might cause.
**Important Article Update**
Bloomberg just reported that China is considering injecting 142 billion USD of capital into banks (“China Weighs Injecting $142 Billion of Capital Into Top Banks“). Needless to say, how massive this news is. I personally suggest everyone take precautions before it is too late.
***
This consideration should not come as a surprise to anyone since we were analyzing this scenario last week (“IS THE MARKET PRICING A FED CUT OR IS A NEW BANKING CRISIS ABOUT TO SPARK AGAIN?“). Never forget that China plays chess, not checkers. Suppose the PBOC is now stepping up to set up liquidity buffers to avoid market disruptions in case of a spike in trading volumes while at the same time, the NFRA announces that they will be injecting capital directly into the 6 big commercial banks. In that case, it means the government is preparing for significant turmoil in the global financial system since, within their local one, there wasn’t a need for direct capital injections (otherwise they would have done it a while ago).
Is all I described today bullish, in particular for stocks? Please let me know what you think.
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