(As written for My Paper on 21 February 2012. Click here to enlarge)
Over the weekend, China announced a 50 basis-point cut in the Reserve Requirement Ratio.
This is essentially the proportion of cash that banks must set aside as reserves. The change will take effect on 24 February, and the figure will fall to 20.5% from 21%.
This is the second time in three months that China has cut its reserve ratio. According to ANZ Bank and UBS AG, the cut may add 350 to 400 billion yuan to the financial system.
“This RRR cut is very good news to the market. It will help release liquidity and allow banks to extend more loans,” HSBC economist Ma Xiaoping told Dow Jones Newswires.
The move is largely seen as an attempt to spur lending as Europe’s debt crisis weighs on exports and a cooling property market threatens economic growth.
Last month, China’s home prices recorded their worst performance in at least a year, with none of the 70 cities monitored by the government posting gains.
According to the National Statistics Bureau, prices in 47 of the cities fell, while home values in the remaining 23 were unchanged from December. New home prices in the nation’s four major cities – Shanghai, Beijing, Shenzhen and Guangzhou – declined for a fourth month.
Let’s explore two questions associated with the cut in reserve ratio:
1. Why didn’t China simply cut their interest rates?
2. What is the impact of the cut in reserve ratio?
China is unable to cut interest rates at this point simply because of their stubbornly high inflation rate. Inflation came in at 4.5% in January, compared to a rate of 4.1% in December. A cut in interest rates at this point will cause inflation to go even higher which will run counter to what China wants.
The main impact of the cut in reserve ratio is an expansion of the money supply. In the current low interest rate environment, the availability of extra cash sloshing around in the financial system will find itself in “risk assets” such as:
- The stock market
- The commodity market
- High beta currencies like the Aussie and the Kiwi
At the time of this writing, the second bailout tranche for Greece (130 billion Euros) has not been announced yet. If it is approved, it will provide another round of positive sentiment in the markets, causing risk currencies to move higher.
Top News This Week
USA New Home Sales. Friday, 24 February, 11pm. I expect figures to come in above 315K (previous figure was 307K).
Long AUD/USD at 1.0715
On the H4 chart, AUD/USD has been on a steady rise, clearing almost 1000 pips in 2 months. The cut in China’s reserve ratio will have a positive effect on risk currencies.
We will place a pending buy order once prices retrace and bounce off the trendline. Our entry will be at 1.0715. A protective stop of 75 pips is placed below the trendline, located 5 pips below the last low.
We will have 2 targets on this trade, exiting the final position at 1.0865.
Entry Price = 1.0715
Stop Loss = 1.0640
1st Profit = 1.0790
2nd Profit = 1.0865