On Tuesday, the People's Bank of China unexpectedly lowered key policy rates for the second time in three months, indicating that policy authorities are intensifying monetary easing efforts to boost the faltering economic recovery. Influenced by the unexpected interest rate cut by the Chinese central bank, the yield spread between Chinese and U.S. 10-year government bonds widened to its highest level since 2007.
In addition to the unexpected rate cut, the Chinese central bank also increased liquidity support to the financial markets through a 7-day reverse repurchase agreement in open market operations, providing the largest liquidity support since February this year.
Compared to other major central banks such as the United States, the United Kingdom, and Europe, the People's Bank of China has been an "outlier" among global central banks for more than a year due to the drag of stagnant economic growth.
The contrasting economic trends and growth prospects between China and the United States have led the People's Bank of China and the Federal Reserve to adopt markedly different monetary policies. This has caused the spread between the yields on Chinese and U.S. 10-year government bonds to widen to 164 basis points, reaching its highest level since February 2007.
The widening yield gap between China and the U.S. has dampened foreign investors' interest in Chinese bonds, stocks, and other assets, with the latest official data showing a decrease in the scale of RMB bonds held by overseas investors in July. David Chao, a global market strategist for Asia Pacific at Invesco, stated that China's recently released economic data has been disappointing, while U.S. data has surprisingly improved. The largest yield gap since 2007 has made international capital more inclined towards U.S. or dollar-denominated assets.
Market observers note that the decline in credit growth and the rising risk of deflation in July forced Chinese monetary policy authorities to adopt more easing measures to support the economy. Defaults and financial distress among large real estate developers and private wealth management companies have shaken overseas investors' confidence in China's financial markets.
The one-year interest rate swap, a measure of investors' future financing cost expectations, fell to 1.84% this week, reaching its lowest level since September 2022. This indicates market participants' expectations that the People's Bank of China may further cut interest rates in the future. However, the PBOC's unexpected rate cuts and the prospect of further reductions have put significant downward pressure on the RMB exchange rate. Since the beginning of the year, the yuan has depreciated about 5.5% against the dollar, becoming one of the worst-performing Asian currencies.
Eugenia Victorino, head of Asia strategy at SEB, stated in a report that although the People's Bank of China needs to take more steps to control the pace of the yuan's depreciation, given the current economic situation in China and risks associated with large real estate developers and private wealth management companies, the PBOC needs to address issues faced by the Bank of Russia, namely the imbalance between economic growth and currency exchange rates.
On Tuesday, the Central Bank of Russia held an extraordinary meeting and decided to raise its key interest rate from the previous 8.50% by 350 basis points to 12%. However, this abrupt increase by the Russian central bank did not change the trend of the ruble's continuous depreciation against the dollar.
Some financial institutions and analysts say that, although there are many differences between China and Russia in terms of economic size, structure, and endogeneity, the issues between the Russian economy and currency need cautious handling by Chinese policy authorities and the central bank.
