Dovish Fed eyed, China's deflationary forces intensify

A look at the day ahead in Asian and global markets

By Jamie McGeever, Columnist, Global Finance & Markets

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If deepening gloom around China and a surging Japanese yen are the local market drivers in Asia, the Fed's upcoming interest rate decision hangs heavily over world markets as growing hopes for a 50 basis point cut push the dollar to new lows for the year.

Wall Street lost ground on Monday even as bond yields edged lower, with jitters beginning to bubble up as Wednesday's Fed decision draws closer.

Rates traders are now putting a 60% probability on a half percentage point cut and expect 120 bps of easing over the three remaining policy meetings this year. That effectively implies two of them will deliver 50 bps cuts.

A file photo shows a jogger running past the Federal Reserve building in Washington, DC, U.S., August 22, 2018. REUTERS/Chris Wattie

This front-loaded dovishness is weighing heavily on the dollar, especially against the yen. The Japanese currency on Monday hit its strongest level since July last year, with the dollar falling below 140.00 yen before regaining that threshold.

Indeed the MSCI index for emerging market currencies, which dates back to 2009, hit a lifetime high on Monday.

The decline in U.S. implied rates and yields is putting Hong Kong interbank rates under downward pressure too. The overnight Hong Kong interbank offered rate or 'Hibor' on Monday hit a one-year low around 2.44%, and one-year Hibor touched its lowest in two years near 4.07%. 

Amidst all this, China's outlook continues to darken.

A "downward spiral", reckons SocGen. "From bad to worse" and "a vicious cycle," says Barclays. "Things could get worse before they get better," warns Morgan Stanley.

These are some of the reactions from analysts at global brokerages to the latest wave of weak economic data that shows not only is the world's second largest economy in deep trouble, but the global spillover cannot be ignored either.

Economists at Goldman Sachs and Citi lowered their 2024 GDP growth forecasts for China to 4.7%, a level notably below Beijing's target of around 5%. Others may well follow suit, and for most of those that don't, the risk to their outlook is firmly to the downside.

Uniformly weak industrial, consumer and house price data on Saturday followed soft bank lending figures on Friday, bolstering the case for aggressive stimulus to shore up demand and growth. 

The trouble is few analysts expect Beijing to deliver the scale of fiscal and monetary support required. Some analysts point to the U.S. and European housing crashes in the Global Financial Crisis and say it could be a decade before China fully emerges from its property sector implosion.

The Chinese 10-year bond yield fell below 2.05% on Monday for the first time ever, nearing a much more symbolically significant break below 2.00%. The two-year yield around 1.35% is near the lows plumbed at the height of the pandemic. 

Graphics are produced by Reuters.

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