China's $1.3T market rally casts shadow on PBOC rate cuts

China’s stock market has recently risen by nearly $1.3 trillion. That sharp increase in August caught analysts off guard. Instead of proof of a strong economy, the rally is now seen as the reward of free money and margin loans.

Officials in Beijing are worried. Policymakers are haunted by the wreckage of the market crash of 2015, when $6.8 trillion worth of value was wiped out. The memory of that collapse now informs how regulators treat the current boom. The central bank, the People’s Bank of China (PBOC), was expected to cut another rate and perhaps reduce the reserve requirement ratio (RRR) from banks before the end of the year. But the rally has complicated that outlook.

“Liquidity could be the primary factor driving the ongoing rally of China equities,” said Yu Xiangrong, head of Greater China economics at Citi. “There is no need to fuel the rally further at this stage.”

Regulators move to contain risks

The PBOC and market regulators aren’t being idle either. Reports indicate they are also looking to make rules on margin financing stricter, a business that reached a record 2.3 trillion yuan, or $322 billion, this month. One of the major factors leading to volatility has been heavy use of leverage.

Other possible steps involve changing short-selling limits and tightening controls over speculative trading. The goal is to keep the market steady, without inciting panic.

The rally, however, has not been evenly distributed. Most buying is from state-backed funds and large institutions, not retail investors. That contrasts with 2015, when individual investors flocked to stocks, exacerbating the crash.

The central bank finds itself in a policy bind. On one hand, it is an economy slowing down. China faces a new trade war with the U.S., weakened confidence in the property sector, and feeble consumer spending. Export figures have disappointed, too.

On the other hand, if rates are cut or liquidity is pumped in further now, there is a risk that assets will become even more overpriced than they already are. Analysts warn that if the rally fades, it could blow household wealth while undermining Beijing’s efforts to encourage confidence in equities as a long-term investment vehicle.

Duncan Wrigley, chief China economist at Pantheon Macroeconomics, said the rally in equities would likely strengthen policymakers’ resolve to avoid broad-based monetary loosening.

Investors watch for delayed easing

Global banks such as Citigroup and Nomura have adjusted their forecasts. Rather than a September shift, they’re now expecting the PBOC to hold off until later this year- at this point, easing would probably be more modest than the aggressive easing that wa s pr iced earlier.

Bloomberg Economics noted that while weakness in the economy supported the case for further monetary easing, the surge in equities meant the PBOC would likely be cautious about injecting more liquidity.

Analysts had previously forecast as much as 40 basis points of cuts over 2025, which would be the biggest easing cycle for the past decade. The likelihood now is for a 10 bp cut and, at best, a 50bp RRR cut by the end of the year.

Instead, the government is moving toward a mix of fiscal measures, infrastructure spending, and tax cuts, rather than an all-out pursuit of monetary easing. That adjustment would provide growth without inflating more risky asset bubbles.

But it is a delicate balancing act. If the equity market soars even higher unchecked, Beijing may be more inclined to cap speculation. But if growth signals evaporate, the central bank may be forced to act again, perhaps as soon as this summer, even as it risks inflating bubbles.

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