In its attempt to create stability, China's central bank assured the markets that it would provide cash to institutions that needed it after the huge volatility created by fears of a banking crisis. It will continue to give cash to institutions that have "temporary" shortages. With the government changing the way it wants the economy to grow, this may not be the last time we hear something like this. It will continue to have an effect on the US markets. Because of this, investors should be cautious in their trading. Let's take a look at what China is doing with its position on lending and what its long-term intent is.
The Chinese government has good intentions, but its policies caused the global markets to react negatively. Wanting to push money into more productive areas of the economy instead of just the "loan market," it tightened up its money policy. The results of this pushed short-term interest rates way up and global markets reacted fearfully that another credit crunch was going to develop.
The central bank is going to do what it needs to do to help lending institutions that are struggling with liquidity right now, but it hasn't backed off its long-term vision to try to balance out a growing economy. Its real focus is to provide cash to the institutions that support what it calls the "real economy." These are lending institutions that have been providing money as loans that are in line with government policy supporting the real economy.
Ling Tao, vice-governor of the Shanghai branch of the PBOC, had this to say after the Chinese central bank showed support for lending institutions:
"The liquidity risk in the banking system is under control; we will stabilize market expectations and guide market interest rates to reasonable."
Evidently the market in China believed what it heard because it recovered all the ground it lost by the end of the trading day. The initial reaction to the Chinese ETF on the NYSE (PEK) also dropped just like the US markets. As you can see on the chart, it also brought stability to the huge drop after the government announcement of its support for banks.
It is not only the markets in China that love this. A combination of good economic reports and China's stability has helped the US markets also rebound. The S&P 500 ETF (SPY) has rebounded nicely on its third straight day of gains. It is not only S&P 500, but the Russell 2000 ETF (IWM) has also rebounded nicely the last three days. Bringing stability back to its banks has had a great influence on all global markets.
While the PBOC softened its position and at least temporarily calmed markets, I am not sure if this is a long-term solution.
This is hard on the markets. Investors should be cautious as this transition takes place in China. There is a real fear tightening funding around the country may make credit conditions tighten. This could cause the economy in China to slow down more than the government expects it to. The government knows that it needs to steer the economy toward a more balanced path and away from investments in infrastructure and property which is debt oriented. The markets may not favor economic decisions by Chinese leadership, and we may experience some short-term reactionary moves because of it.
President Xi Jinping has been trying to cool the lending process and turbulent markets where the results of nervous investors who are aware of the risks that the government faces dealing with this debt problem. The biggest risk China faces may be mishandling of the situation and causing panic instead of creating responsible regulations for the banks.
Even though the markets in China have dropped almost 20% since their peak in mid February some analysts believe that it's going to drop further as the government adjusts how it wants the economy to grow. The Chinese government has taken the position that it wants small and medium banks to manage their liquidity, and manage it now. It is going to restrict credit growth, and this means the probability of downside risk at least in the short term is high.
Investors really need to be cautious and defensive right now.
In the short term, I would stay tuned to what is happening in China. The Chinese government's stance on lending is geared toward providing balanced long-term economic growth but at a modest single-digit pace. The transition is expected to be rocky as the changes take place in the Chinese economy. The probability of swings in the US market because of this is pretty high. For this reason, keep track of what's happening in China and trade cautiously.