Chart: Chinese Rate Hike Doesn’t Matter

For the second time this year and the fourth time since 2010, the Chinese government raised interest rates by 25bp, bringing its lending and deposit rates to 6.31 and 3.25 percent. Like many other countries around the world, China is worried about rising inflation pressures and the negative impact that it could have on inflation expectations and the overall economy. Over the past year, China has tried to combine rate hikes with higher reserve requirements for banks and the results have been limited. The recovery in the global economy has boosted growth expectations for China, forcing the central bank to take continued actions to slow their economy. While the timing of the announcement was a surprise, everyone expected more tightening from China because of the strength in commodity prices. In addition, China rarely make one-off moves which explains why the market’s reaction to China’s rate hike was so muted. High yielding currencies initially sold off after China’s announcement but since then, they have recuperated nearly all of their losses.

Diminishing Impact of Chinese Rate hikes

Each Chinese rate hike has had a smaller and smaller impact on the currency market. The first rate hike back in October elicited the biggest reaction because it was the first rate hike in nearly 3 years. At the time, all of the pro-cyclical currencies plunged against the U.S. dollar with the euro falling 1.5 percent and the Australian dollar declining by more than 2 percent. When China raised rates again on Dec 27th, the euro ended the day slightly higher against the U.S. dollar while the Australian dollar remained unchanged. In February, the reaction was slightly larger in the EUR/USD, GBP/USD and USD/JPY but the AUD/USD and NZD/USD ended the day higher. The price action today is even more muted as indicated in the chart below which suggests that investors are skeptical about China’s ability to tame their roaring economy. Slower Chinese growth is undoubtedly negative for global growth but we have been down this road before and even though there have been signs of slower growth in the Chinese economy, it has not had a significant impact on demand.

Rising inflationary pressures is the primary motivation behind China’s rate hike. With commodity prices continuing to rise, China did not want to take any risks, opting to preempt a further increase in inflationary pressures by raising interest rates. Given the health of the Chinese economy and the prospect of stronger global growth, we have not seen the last of China’s policy actions. We expect more interest rates hikes and more reserve requirement ratio hikes in 2011.

*April reaction is based on currency value change from Chinese rate hike announcement to 9am NY Time / 13:00 GMT

Diminishing Impact of Chinese RRR

China raised their reserve requirement ratio today for the third time this year and the ninth time since the beginning of 2010. I don’t have time to write much about this but I want to point out that Chinese is having a diminishing impact on the market.

This is what I wrote last month:

With each Chinese rate hike, there has been a smaller and smaller impact on the currency market. The first rate hike back in October elicited the biggest reaction because it was the first rate hike in nearly 3 years. At the time, all of the pro-cyclical currencies plunged against the U.S. dollar with the euro falling 1.5 percent and the Australian dollar declining by more than 2 percent. When China raised rates again on Dec 27th, the euro ended the day slightly higher against the U.S. dollar while the Australian dollar remained unchanged. The price action today is very similar to December which suggests that investors are skeptical about China’s ability to tame their roaring economy. Slower Chinese growth is undoubtedly negative for global growth but we have been down this road before and even though there have been signs of slower growth in the Chinese economy, it has not had a significant impact on demand. The Reserve Bank of Australia for example has recently attributed their rosier outlook to a strong Chinese economy.

Unsurprisingly, rising inflationary pressures is the primary motivation behind China’s rate hike. We have been looking for another rate hike from China since they tightened in December and with prices rising due to geopolitical risks, the Lunar New Year and a recent drought in the grain producing Northeast part of the country, China did not want to take any risks, opting to preempt a further increase in inflationary pressures by raising interest rates. Given the health of the Chinese economy and the prospect of stronger global growth, we have not seen the last of China’s policy actions. We expect more interest rates hikes and more reserve requirement ratio hikes in 2011. Although these actions will drive the Chinese Yuan higher, if global growth is supported by other countries around the world, it will soften the blow of Chinese tightening.

Impact of Last 3 China Rate Hikes on FX

With each Chinese rate hike, there has been a smaller and smaller impact on the currency market. The first rate hike back in October elicited the biggest reaction because it was the first rate hike in nearly 3 years. At the time, all of the pro-cyclical currencies plunged against the U.S. dollar with the euro falling 1.5 percent and the Australian dollar declining by more than 2 percent. When China raised rates again on Dec 27th, the euro ended the day slightly higher against the U.S. dollar while the Australian dollar remained unchanged. The price action today is very similar to December which suggests that investors are skeptical about China’s ability to tame their roaring economy. Slower Chinese growth is undoubtedly negative for global growth but we have been down this road before and even though there have been signs of slower growth in the Chinese economy, it has not had a significant impact on demand. The Reserve Bank of Australia for example has recently attributed their rosier outlook to a strong Chinese economy.

Unsurprisingly, rising inflationary pressures is the primary motivation behind China’s rate hike. We have been looking for another rate hike from China since they tightened in December and with prices rising due to geopolitical risks, the Lunar New Year and a recent drought in the grain producing Northeast part of the country, China did not want to take any risks, opting to preempt a further increase in inflationary pressures by raising interest rates. Given the health of the Chinese economy and the prospect of stronger global growth, we have not seen the last of China’s policy actions. We expect more interest rates hikes and more reserve requirement ratio hikes in 2011. Although these actions will drive the Chinese Yuan higher, if global growth is supported by other countries around the world, it will soften the blow of Chinese tightening.

AUD/USD and Chinese Reserve Requirements

I have been bullish Australian dollars for some time not only because I have witnessed first hand the strength of the Australian economy earlier this year but also because the central bank is slated to raise interest rates again in Feb. Australia’s recovery is largely thanks the expansion in China. Earlier this week, China reported a sharp rise in exports that propelled the country into the ranking of the world’s #1 exporter. This is a huge positive for Australia and the Australian dollar because China has been hungry for Australia’s commodities.

This morning, China also raised their reserve requirement to cool their economy (I wish the U.S. was in the same enviable position) and JP Morgan published this awesome chart illustrating the correlation between China’s reserve requirement and the AUD/USD. According to their report:

The sample covers 19 increases since July 2006. As is clear, commodities on average appreciate and the dollar depreciates following a tightening in reserve requires. The most consistent performer is AUD, which appreciates 75% of the time following a reserve hike.

Technically the 9120 level represents decent support for the AUD/USD and I think any losses will be limited to that level. Next stop for AUD/USD should be 94 cents.

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chinareserveaud

AUD/USD Chart:

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