China did what the market was looking for (on Monday) by easing policy, but it appears that the markets want more. Thanks, but we are not quite happy yet.

After a very weak equity session in China yesterday, China’s PBoC announced in the London session, that they were cutting the reserve requirement for banks by 50bp (expected) to 18% and that they would ease interest rates 25bp for one year lending (to 4.6%) and deposit rates (to 1.75%). This was not expected, but it wasn’t a bazooka either.

It did, however, lead to a surge in European and US equities, oil prices were higher, yields higher and the USD recovered. EM currencies enjoyed it too. We will know more today, but it seems that in the last hour of US trading, markets have assessed it and decided that the policy isn’t enough. The Dow ended the day -1.3%, the USD is selling off, as is the AUD. In the AUD, we are back where we were at the start of yesterday. This is despite the Shanghai equity market dropping -7.6% yesterday, and the Dow being up over 3% earlier today. Measures of risk aversion, such as the VIX are still elevated, which makes it difficult for the AUD.

It is a positive step that Chinese policy makers have chosen to address the economy rather than prop up the equity market directly. The Chinese equity market does not make up a huge proportion of local wealth, the importance here is on household and consumer sentiment (released today). But far more important, and potentially worrying, has been the rise in interest rates.

A lot of debt has been generated on the back of low interest rates. And, not all is long dated debt. Current interest rates are rising, as a result of the currency intervention to prevent CNY weakening even further post the recent relaxation of the currency management regime. As rates rise, it becomes more expensive to roll that short dated debt. Then, add the pressures of debt that is denominated in USD as the currency weakens.

Thus the current pressures are not about just the equities but broader than that. So the policy to cut the reserve requirement and interest rates is a step in the right direction. But, as Christy Tan, our Asia Strategist notes, “similar moves will be repeated if necessary.” The reaction in the US appears to be that more might be necessary.

It was also positive to see that in the announcement was a mention of the fact that over one year deposit rates would no longer be capped. This adds to the liberalisation of deposits. It also makes sense of the news yesterday that there would be a clamping down of non-official banks.

So, today we will be watching closely to see how Chinese markets take the news: how much does CNH rise? Where are market interest rates? If they are lower, there may be some weakness in the Chinese currency. And, not that it mattered much to Australia yesterday, but were does the equity market go. The policy announcement is not yet the likely end of the story.

The ECB also make this clear, with Constancio, while noting that they would do what was necessary, also noting that it was too early to fully understand the impact (of China). The German IFO, at least, was encouraging, by rising more than expected.

The US markets have been busy removing the probability priced of the Fed hiking this year: sorry, you may have missed your chance they are suggesting (a small amount is still priced). But the local economic data was pretty good last night, with consumer confidence rising, house prices rising and home sales ok.

Coming Up

It will be difficult for markets to tear themselves away from the regional market moves long enough to respond to the data today. We get the inputs to GDP: construction work done and capital expenditure. Capex has had a big impact on AUD on past occasion, but it would have to be a very big outcome, validating the current mood of the market, to have an influence today. The RBA’s Stevens also speaks, so unless he talks about the current market moves, it will likely fade into the background. He is talking at a “reform summit.” In NZ we get the trade data, which is forecast to deteriorate.

The ECB’s Praet, the chief economist, has been known to signal a change in idea or theme in the ECB’s thinking and as such, his speech should be watched.

US durable goods orders are typically volatile, so the Fed’s Dudley who is a voting dove, might get a lot of attention.

Overnight

On global stock markets, the S&P 500 was -1.40%. Bond markets saw US 10-years +8.55bp to 2.09%. On commodity markets, Brent crude oil +0.73% to $43, gold-1.2% to $1,140, iron ore +0.3% to $53.45. AUD is at 0.7127 and the range was 0.7123 to 0.725.

• China cuts RRR 50bp, cut 1 year lending rate to 4.6% and deposit rate 25bp to 1.75%. They remove the ceiling on deposits >1 year. The RRR for financial leasing cut an additional 3ppts.
• German IFO 108.3E, 108E, 107.6P
• US July consumer confidence 101.5A, 93.4E, 91P
• US New home sales +5.4%A, 5.8E, -7.7P
• US Markit PMI 55A, 55.7P
• US house price inde3x 1.2%A, 1.2E, 1.5P

For full analysis, download report:

• Markets Today: 26 August 2015 (PDF, 300KB)

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