China’s Interest Rate Cut Sparks Market Sell-Off

A surprise interest rate cut by People’s Bank of China (PBOC), the country’s central bank, confused financial markets on Monday, sending global equity indexes on a tailspin. 

The sell-off began in Asia, with Japan’s Nikkei 225 losing 2.13% in overnight trading, the Shanghai’s Composite Index losing 1.07%, and Korea’s Kospi 1.8%. Then, it spread to Europe, with major equity market indexes dropping around 2%. Meanwhile, at 8 p.m., U.S. equity futures were pointing to a lower opening with Nasdaq, and the Russell 2000 futures hit the hardest.

China’s 0.5% surprise rate hike comes a couple of weeks after PBOC released $188 billion of liquidity into the banking system. It also comes when major central banks around the world are moving in the opposite direction.

Last week, both the Federal Reserve and the European Central Bank announced that they would speed up tapering, the rolling back of their bond-buying programs, meaning that they will stop adding liquidity into their banking systems. 

In addition, they are preparing markets for an eventual tightening, meaning taking liquidity out of the systems, something the Bank of England is already doing by raising interest rates.

The diverging policies of the world’s central banks create a great deal of confusion among traders and investors regarding the state of the world’s second-largest economy.

Why is China’s central bank is moving in the opposite direction from other central banks? The quick answer is that China doesn’t face the same inflation pressures as other large economies. For instance, China’s consumer price inflation rose 2.3% in November 2021, up from 1.5% in October, well below the 6.8% rise in the U.S. and 4.9% in ECB. 

Then there’s China’s economy slowing down due to a scale back in the spending of its consumers. For instance, China’s retail trade growth rose at an annual rate of 3.9% in November 2021, down from 4.9% in October, well below the market forecast of a 4.6% increase, due to widespread COVID-19 outbreaks.

There are also concerns about China’s exports. One of China’s growth engines will take a big hit by the restrictive policies of the Federal Reserve and the European central banks. The U.S. and the European Union are China’s largest export markets, and higher interest rates could dampen the demand for Chinese products.

Still, there’s one more factor behind POBC’s odd monetary policy move — the most important, in my opinion. China’s property bubble is beginning to burst. For instance, China’s new home prices rise have been stalling, and construction has been falling in recent months, which has taken its toll on the country’s developers. 

In September, debt-ridden China Evergrande’s (OTC: EGRNF) warned that it is the target of a hostile media campaign, which could undermine its sales in September, prompting a big sell-off in its shares and bonds maturing in 2024, which spread to other Chinese real estate and property companies. This week, Kaisha Group Holdings announced that it missed bond payments.

Apparently, there’s a credit-crunch brewing in the world’s second-largest economy, amplified by the renewed spread of new COVID-19 variants. 

That sounds like China’s Lehman moment for traders and investors who have survived Wall Street long enough. Thus, the rolling of sell-offs in Chinese property shares and the spreading of that sell-off into every risky asset around the globe.

The POBC must do whatever it takes to ensure that the credit crunch doesn’t turn into a liquidity crunch.

Disclosure: At the time of publication, Panos Moudoukoutas did not have a position in any securities mentioned in this article.