Futures Outlook - An Excerpt from CRB'S Futures Market Service

Chinese rate hike would be just temporarily bearish and would be a net positive for the global economy

The Chinese central bank may be on the verge of an interest rate hike within the next several weeks. A Chinese rate hike would likely push the world’s stock markets lower for a short period of time. However, a rate hike would be a sign that normality is returning and would provide reassurance that the Chinese government is intent on preserving the economic expansion and not allowing a runaway boom to develop that eventually turns into a bust. The world needs a strong and steady Chinese economy to continue to be an engine for the global recovery.

There is plenty of room for a Chinese rate hike. At the beginning of the financial crisis in late 2008, the Chinese central bank cut its benchmark 1-year rate by a total of 216 bp from 7.47% to 5.31%. The benchmark rate has been at 5.31% since December 2008. The Chinese central bank could announce one its typical 18 bp or 27 bp rate hikes in order to signal that it intends to keep inflation under wraps and prevent inflation panic from developing in the Chinese bond market.

The pressure for a Chinese rate hike is growing. China’s CPI in February was just reported at +2.7% y/y, the highest level in 1-1/2 years and just under the government’s ceiling of about 3%. There are other  indications that the Chinese economy is close to overheating from the stimulus measures taken in the past 1-1/2 years. Chinese GDP growth accelerated to +10.7% in Q4-2009, up sharply from the cyclical trough of +6.2% posted in Q1-2009. Other strong economic data includes: Jan-Feb industrial production +20.7%  y/y, Jan-Feb retail sales +17.9% y/y, urban fixed-asset investment +26.6% y/y, and producer price inflation +5.4% y/y. These figures are from depressed year-earlier levels, but nevertheless indicate an economy that is no longer in need of excessive stimulus.

The Chinese central bank has already surprised the market with two bank reserve ratio hikes so far this year, which indicates that the central bank is not likely to be shy about a rate hike. There is also the outside possibility of a revaluation of the yuan in coming months from the fixed rate near 6.8 yuan/dollar seen in the past 1-3/4 years.

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