Three categories and two stages of interest rate inversion in China and the United States
Since 2004, the upside down (sharp narrowing) of the maturity yield of China US 10Y treasury bonds has occurred 10 times, which can be divided into three categories and two stages:
Three categories: 1) Sino US policy differentiation, with a total of 5 times on US debt and under Chinese debt; 2) The interest rates of China and the United States rose at the same time, but the rise of US bonds was faster, four times in total; 3) The interest rates of China and the United States fell at the same time, but the decline of China's bonds was faster, which occurred once.
Among these three categories, the upside down or sharp narrowing of China US interest rate spread caused by China US policy differentiation occurs the most frequently and lasts relatively long.
Two stages: Taking 2010 as the boundary, before 2010, the frequency and range of interest rate spread inversion between China and the United States were higher and larger; After 2010, the interest rate gap between China and the United States narrowed significantly, and there was little upside down.
The reason behind this may be that after 2010, the maturity yield center of US Treasury bonds moved down sharply (from 4% to 2%), while China remained relatively stable, which turned the upside down of China US interest rate spread into a narrowing of interest rate spread.
Similar interest rate increase and table reduction: the most referential year in 2018
1) the United States raised interest rates and reduced interest rates, while China continuously lowered reserve requirements. At that time, under the influence of trade war plus deleveraging, the downward pressure on China's economy increased, while the US economy recovered strongly stimulated by tax cuts. The interest rate gap between China and the United States narrowed continuously, which led to the narrowing of the basic interest rate gap between China and the United States. The low point of China US interest rate spread was 24bp, which appeared in November 2018.
2) the narrowing of interest rate spread leads to capital outflow. When the interest margin between China and the United States narrowed to less than 80bp, the capital began to flow out significantly. The amount of domestic bond custody held by overseas capital decreased from about 120 billion yuan in June 2018 to about - 30 billion yuan in November. The net transaction volume of land stock connect decreased from about 50 billion yuan in June 2018 to about - 10 billion yuan in October.
3) rapid depreciation of RMB exchange rate. When the 10Y interest rate spread between China and the United States narrowed to less than 80bp, the central parity rate of the US dollar against the RMB began to rise significantly, and stood at a high of 6.9 with the 10Y interest rate spread narrowed to a low. During this period, the RMB exchange rate was adjusted and depreciated by about 6000 basis points. Of course, the sharp depreciation of the RMB is not only affected by the narrowing of the interest rate gap between China and the United States, but also related to the obvious contraction of the current account and financial account balance caused by China US trade friction.
3) bonds perform better than stocks and commodities. Affected by the weakening of China's economic fundamentals and the continuous reduction of reserve requirements by the central bank, the bond performance was relatively dominant during the narrowing of the interest rate gap between China and the United States. Commodities and stocks fell significantly, among which banks, insurance, coal, crude oil and other undervalued and resource industries were relatively resistant to decline.
How will this round of China US interest rate spread upside down be interpreted?
1) the upside down time of interest rate difference between China and the United States may continue to Q3: Q2. With the help of the Federal Reserve's interest rate increase and table contraction, the yield of 10Y US bonds is expected to continue to rise, with a high point near 3.2%; Under the disturbance of the epidemic, the downward pressure on China's economy has increased, the monetary policy has remained relatively loose, and the yield of 10Y medium-term bonds is likely to fluctuate by 2.7% - 2.9%.
After Q3, the inhibitory effect of interest rate hike on the US economy will appear, the US economy will gradually slow down, inflation is expected to fall significantly, the expectation and rhythm of interest rate hike will slow down, and guide the long-term interest rate downward. With the improvement of the epidemic situation in China, the macroeconomic disturbance factors are weakened, and the effect of the early steady growth policy is shown. The signs of economic stabilization will be more obvious, and the long-term interest rate is expected to rise slightly. The interest rate gap between China and the United States will also gradually widen.
2) the RMB is facing devaluation pressure, but the range should be less than that in 2018: since April, the RMB exchange rate has been devalued by about 2000 basis points. The rapid outflow of funds under the upside down interest rate difference between China and the United States and the weakening of China's economic fundamentals under the disturbance of the epidemic are the main reasons for the rapid devaluation of the RMB. During the last round of narrowing the interest rate gap between China and the United States, the RMB exchange rate was devalued by about 6000 basis points. Therefore, the devaluation process of the current round of RMB may not be over.
However, there is still a significant surplus in China's current account balance, and the central bank's foreign exchange reserves and foreign exchange deposits of financial institutions are also relatively abundant, which can reduce the range of RMB devaluation to a certain extent. In addition, on April 25, the central bank announced that from May 15, it would reduce the foreign exchange deposit reserve ratio by 1 percentage point (9% to 8%). The reduction of foreign deposit reserve ratio can also alleviate the unilateral depreciation expectation of the market and reduce the fluctuation rhythm. Therefore, on the whole, the depreciation process of RMB may not be over, and the peak may be around 6.8, but the depreciation rhythm will gradually ease under the control of the central bank's policies.
How will the broad categories of assets perform? Bonds may be superior to stocks and commodities
1) bond market: the core contradiction of the bond market is still the fundamentals of China's economy. Although the upside down of the interest rate spread between China and the United States will make the central bank choose some relaxation tools, the direction of the central bank's "self dominated" monetary policy will not change, the subsequent monetary policy will remain loose, and the bond market will also show some performance.
With the downward trend of interest rate pegging between China and the United States in August and April, the interest rate pegging between China and the United States will gradually disappear, and the interest rate pegging between China and the United States will continue to weaken.
3) commodities: the Fed's interest rate increase and contraction will help the US dollar index strengthen, and then suppress commodity prices.
Risk tips
Macroeconomic and industrial policies have changed more than expected.
