On March 22, 2018, Beijing time, the Federal Reserve announced its first interest rate hike of the year.
The FOMC statement indicated an increase of 25 basis points to a range of 1.50%-1.75%, maintaining the expectation of three rate hikes within the year, but anticipated a steeper increase in 2019-2020.
Will China follow the Federal Reserve's interest rate hike? If so, in what manner? What will be the impact on the market?
Will China Follow with an Interest Rate Hike?
Yi Gang, who has just succeeded Zhou Xiaochuan as the Governor of the People's Bank of China, stated at a press conference during the National Two Sessions: China's monetary policy is primarily based on domestic economic and financial conditions, and we will conduct a comprehensive assessment.
Zhou Xiaochuan mentioned at the National Two Sessions: Many major countries are gradually exiting quantitative easing; China is also part of the global economy, and the impacts in this regard should be predictable.
Historical data shows that the central bank raised the open market interest rate three times in 2017, two of which occurred on the same day the Federal Reserve announced its interest rate hike.
Regarding the reasons for raising the open market interest rate, the central bank pointed out in the "2017 Fourth Quarter China Monetary Policy Implementation Report" that a slight increase in open market operation rates can moderately narrow the spread with money market rates, help correct market distortions, streamline the monetary policy transmission mechanism, and objectively assist market participants in forming reasonable interest rate expectations, avoiding excessive leverage and broad credit expansion by financial institutions.
How Will China Raise Interest Rates?
Most domestic analysts believe that if the Federal Reserve raises interest rates, China will follow suit, as the trend of normalizing monetary policy globally is relatively clear. For China, aligning with the global trend of monetary policy normalization is a better choice, while opinions on the method of interest rate hikes vary.
Three methods are listed below:
(1) Adjusting the OMO rate for new interest rate hikes will replace the old method of adjusting the benchmark deposit and loan rates.
(2) If the Federal Reserve raises interest rates, the People's Bank of China will increase the reverse repurchase rate to signal policy changes, with an increase of about 10 basis points, which may be more pronounced.
(3) The People's Bank of China may follow with a rate hike on the official benchmark rate.
Housing Loan Rates Are Expected to Rise
According to personnel from a well-known real estate agency: Currently, the average interest rate for first-time home loans nationwide has risen to 5.43%, which is equivalent to 1.11 times the benchmark rate.
Based on the aforementioned overall interest rate levels and considering the accelerated pace of the Federal Reserve's interest rate hikes, the interest rate for first-time home loans is expected to continue to rise in 2018.
Even the yield on bank wealth management products has exceeded 5%, making it a losing proposition for banks to offer home loan rates of 4.9% or lower to homebuyers.
As for second home loan rates, the upward space is even larger.
A-shares Face Negative Pressures, Bond Market May Be Under Pressure
What does it mean if China follows with an interest rate hike?
Currently, market deposit and loan rates have already risen ahead of the official benchmark rates; even if the central bank raises the official benchmark rates, it may only be a confirming action, but it carries significant symbolic meaning.
Some brokerage personnel pointed out that an interest rate hike could have a significant negative impact on U.S. equity assets and even Chinese A-shares, as evidenced by the recent adjustment in U.S. stocks and the noticeable reduction in the scale of inflows from the Stock Connect program.
In terms of the bond market, considering the international policy cycle, economic cycle, and interest rate spread distortions, the domestic bond market remains under pressure, with the yield on 10-year government bonds expected to gradually rise to a central level of 4%.
Is the Bull Market in U.S. Stocks Coming to an End?
Goldman Sachs pointed out: Theoretically, interest rate hikes have a negative impact on the stock market, as higher interest rates mean increased financing costs for listed companies, which naturally leads to lower stock price returns if performance remains unchanged.
However, based on historical experience, interest rate hikes have also been accompanied by rising stock prices. The above chart shows that from 1970 to 1998, stock market valuations and interest rates were negatively correlated, while in the last 20 years, they have been positively correlated.
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