China's Inflation Moves May Hurt Stocks, Bonds

Sunday, 21 November 2010 04:45 PM

China’s stocks and bonds may fall, and yuan forwards may advance, as the world’s fastest-growing major economy increases the amount of money that banks must set aside to fight inflation.

iShares FTSE/Xinhua China 25 Index Fund, an exchange-traded fund, sank 1 percent in the U.S. after the Chinese central bank ordered a 50 basis point increase in reserve ratios for banks. Twelve-month non-deliverable yuan forwards rose 0.1 percent to 6.4587, reflecting bets the currency will appreciate 2.7 percent in a year.

The reserve ratio increase by the People’s Bank of China to cool the fastest rise in consumer prices in two years was the second in two weeks. China’s benchmark stock index had its biggest two-week decline since May on speculation the monetary tightening will crimp economic growth.

“When a country is in an inflation-fighting mode, it’s typically not good for equities,” said Jim Oberweis, who oversees $10.3 billion as the president of Oberweis Asset Management Inc., in Lisle, Illinois, on Nov. 19. “The growth story is still positive, but I’m a little concerned that inflation will be a cap on the stocks.”

The Shanghai Composite Index gained 0.8 percent on Nov. 19 before the reserves ratio announcement, trimming the weekly decline to 3.2 percent after sliding 4.6 percent the previous week. The yield on the 3.29 percent government bond due September 2020 rose three basis points to 3.90 percent. It has climbed 50 basis points in the past month. One-year yuan interest-rate swaps climbed to the highest level since October 2008 in Hong Kong.

Later in U.S. trading, American depository receipts of China Construction Bank Corp., the nation’s second-largest lender, slumped 3 percent to $48. Bank of China Ltd., the country’s No. 3 lender, lost 3.4 percent to $14. The American Stock Exchange China Index decreased 0.5 percent to 232.78.

The latest move to contain excess liquidity came after Premier Wen Jiabao held a Cabinet meeting earlier in the week and called for a crackdown on speculation in agricultural goods and ordered price caps on “daily necessities” if needed.

Regional authorities must report before Nov. 30 on their progress in stabilizing prices of essential services and goods including food, the State Council said in a circular Nov. 20 on its website. The notice also formally stated measures to ease inflationary pressures as formulated in the meeting chaired by Wen Jiabao.

“If you think about what threatens the leadership in China, inflation probably is on the top of their list as it disproportionally hurts the poor,” Oberweis said.

Officials are seeking to rein in the money supply after the Federal Reserve expanded U.S. stimulus with a plan to buy $600 billion of Treasuries, spurring capital flows into Asia. Inflows of money from the trade surplus, foreign direct investment, and investors betting on gains by the yuan threaten to propel consumer prices after unprecedented lending by banks flooded the economy with cash from late 2008. Consumer prices rose 4.4 percent in October from a year earlier.

“This move is not enough to tame inflation,” said Philip Schwartz, who manages about $1.2 billion of international equities in New York at ING Investment Management. “They will become more aggressive; they have to raise interest rates,” he said, predicting further gains in the currency. The yuan has advanced 2.8 percent versus the dollar after China scrapped a two-year peg on June 19.

One-year interest-rate swaps, the fixed rate needed to receive the floating seven-day repurchase rate, rose as much as 14 basis points to 2.83 percent on Nov. 19 in Hong Kong, according to data compiled by Bloomberg.

HSBC Holdings Plc, BNP Paribas SA, Citigroup Inc., Credit Suisse Group AG, UBS AG and Australia & New Zealand Banking Group Ltd. are among lenders predicting that the central bank will add this year to the quarter-point increase that took the benchmark one-year lending rate to 5.56 percent and the one-year deposit rate to 2.5 percent.

“People had thought we were nearer the end of the China tightening cycle, and China is now giving a very clear indication that they’re very intent on conquering inflation,” Philippe Langham, who manages the $653 million RBC Emerging Market Fund in London, said in an interview on Nov. 19. “The tightening is being extended further than market participants had thought.”

The Bank of New York Mellon China ADR Index, containing ADR’s from China and Hong Kong listed on the New York Stock Exchange and Nasdaq, pared a loss of as much as 1.3 percent after the reserves ratios announcement, closing just 0.1 percent lower on Nov. 19.

There will be “a very attractive opportunity” to buy Chinese stocks as “we get towards the end of the China tightening cycle,” particularly those sensitive to interest rates, Langham said. “It’s probably early now, but we’re brewing towards quite an attractive opportunity,” he said.

The Shanghai composite has lost 8.6 percent since reaching a seven-month high on Nov. 8 on speculation the government will raise interest rates and impose price controls.

Across Asia, China’s inflation compares with deflation in Japan, and on the other extreme, a 9.8 percent rate in India. In the U.S., consumer prices rose 1.2 percent last month from a year earlier.

On Nov. 10, the central bank said it was raising banks’ reserve requirements by 50 basis points. The tightening followed a 25 basis-point increase in benchmark deposit and lending rates on Oct. 19, the first in almost three years.

The reserves ratio will probably be raised by a further 50 to 100 basis points before year-end, said Lu Zhengwei, a senior economist at Industrial Bank Co. in Shanghai. It’s “very likely” the central bank will also increase interest rates as early as the first half of December, when November inflation figures are due, he said.

“There’s still enormous pressure from international capital inflows,” Lu said.

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Sunday, 21 November 2010 04:45 PM
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