How the Fed Holding Fire Impacts China Markets

MARKET REACTION: The Federal Reserve has indicated it will hold interest rates in the US. What impact does this central bank policy have on Asian stock markets?

Emma Wall 1 February, 2019 | 10:39AM
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Emma Wall: Hello, and welcome to the Morningstar series, "Market Reaction." I'm Emma Wall and I'm joined today by GAM's Rob Mumford to talk about China and the Fed.

Hello, Rob.

Rob Mumford: Good morning.

Wall: So, we had this week that the Fed has taken a slight change in tack when it comes to interest rates. And we are sitting here in Asia and of course, central bank policy in the US. doesn't just affect the US. What impact is that decision going to have on China?

Mumford: Yeah. Not just a subtle shift, quite a dramatic shift. December, they were talking about further rate hikes ahead. Now, Fed funds futures saying actually perhaps the next move maybe down, not up. So, a very, very big shift.

It's positive. Obviously, markets had a very tough time last year. And it was all about a tightening path in the face of actually what looked like slower growth, particularly in this part of the world. So, the markets have reacted well, and I think that's right.

Wall: And do you think central bank policy, be it in the Fed or be it localised in Asia and in particular, China, has a larger impact on markets? Or are we still going to be dominated by trade war rhetoric this year?

Mumford: Yeah, obviously, US monetary policy guides global monetary policy. And again, that was the problem last year. We had this real withdrawal of liquidity as the Fed tightened and also, you saw the Fed balance sheet contracting. And I think the other dramatic shift the other night was talking about the balance sheet contraction specifically and how they may adjust that. So, yeah, US monetary policy guides global monetary policy. Big impact last year. We saw the deficit countries having to raise rates, again putting a lot of pressure on equity markets. So, the fact that things seem to be levelling off at least, very positive for equities.

Wall: Does that mean that you are then bullish on Chinese equities for 2019?

Mumford: China, you know, is one of the key worries. So, we are worried about tighter US monetary policy and we are worried about the path of China growth. What we saw before the US shift obviously was significant, both monetary and fiscal, announcements coming out China from, what, the second half of last year. So, the path of growth in China is still a real worry, but we had a much earlier policy reaction and the pace of that reaction seems to be accelerating. And this is where we should touch on the trade issue.

Because clearly, global tariffs are a tax on growth. And if we are worried about China, particularly worried about that segment of the economy, highly indebted, very narrow margins, so growth is really bad news for them. But what we are hoping at least at this point is that the policy responses will lead to actual real economic response, but it's not going to happen until the second half. So, we are positive on China equities from a valuation standpoint, from the path of policy. The jury is out in terms of the effectiveness of that policy and we are positioned accordingly.

Wall: And I suppose also one should not underestimate the power of sentiment. Having the Fed hold on rates and as you say, even indicate there maybe a cut in the next decision-making, that has caused positive sentiment flow back to China, even before we see the policy impact in the second half of the year. Could that enough to lift markets?

Mumford: Yeah, I think so. And we are talking about markets but also the real economy. And I think the overhang of what the Fed was doing and what was going on in trade, I think when we look across the border, many people are becoming more defensive in terms of their activity. And this causes real problem in terms of liquidity, in terms of cash flow management. So, yes, I think from both a real economy standpoint, I think there will positives from there. And from an equity standpoint, obviously, we've already seen markets very strong early part of this year and the last few days definitely a supporting element. There are concerns out there, but from an equity standpoint which at the end of last year was discounting quite sort of severe pullback if not recession, too much, particularly in the face of policy response.

Wall: Rob, thank you very much.

Mumford: Thank you.

Wall: This is Emma Wall for Morningstar. Thank you for watching.

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Emma Wall  is former Senior International Editor for Morningstar

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