The People’s Bank of China (PBOC) maintained its main policy rate at 1.40%, despite the Federal Reserve’s rate cut. Resilient exports and a stock market nearing decade highs enabled Beijing to hold off on rate adjustments, even as the economy shows signs of deceleration.
Data from August displayed a less severe economic downturn than anticipated, possibly allowing authorities to postpone some stimulus to the following year. A modest 10 basis point rate cut might be considered if the markets correct, but there are concerns that more substantial easing could lead to a stock bubble.
Policy Support Predictions
Analysts predict that policy support might be introduced later in the year to help achieve China’s growth target of approximately 5%. Additional measures are anticipated in the fourth quarter, but longer-term structural reforms, expected to be discussed during the October plenum, remain a focus.
With the People’s Bank of China holding its key rate at 1.40% while the US Federal Reserve just trimmed its own, a clear policy divergence has emerged. This is keeping the offshore yuan, the CNH, strong, with the USD/CNH pair currently trading near a yearly low of 7.15. For now, we see this stability as an opportunity to sell short-dated call options on USD/CNH, collecting premium while the interest rate differential favors the yuan.
The calm in Chinese equities, with the CSI 300 index pulling back slightly from its recent decade high of 5,900, feels temporary. Implied volatility on A-share index options has fallen to multi-month lows, making protective puts relatively cheap. We believe purchasing out-of-the-money puts on major indices is a prudent hedge against a potential market correction, which could be triggered by any sign of weakness ahead of the growth target.
Upcoming October Plenum
The upcoming October plenum is a major event risk that the market is underpricing. While authorities are holding back on stimulus now, citing better-than-expected August industrial production of 4.1%, the underlying weakness shown in retail sales growth of only 2.8% is a concern. We are positioning for a rise in volatility by buying straddles on the Hang Seng Tech Index, as policy announcements from the plenum could cause a sharp move in either direction.
Looking back, we saw a similar situation in late 2021 when policy uncertainty led to sharp swings in the market before year-end. Given that Beijing must still meet its “around 5%” GDP growth target for 2025, some form of stimulus in the fourth quarter is almost inevitable. The current quiet period is therefore a valuable window to build positions that will benefit from the policy action that must eventually come.
