Emergency Fed rate cut helps China with longer-term currency goals

• The Fed surprised markets during the New York trading session on Tuesday with a half percentage-point rate cut two weeks before a scheduled meeting.
• The U.S. central bank's loosening of monetary policy will likely accelerate similar moves by the People's Bank of China, said Zhao Bowen, research director at Beijing-based Blue Stone Asset Management. 
• While the timing and exact scale of expected PBOC  rate cuts vary, analysts pointed out the Fed's move will keep the Chinese yuan from weakening too much, alleviating concerns about capital outflows.

A man wearing a mask walks past the headquarters of the People's Bank of China, the central bank, in Beijing, China, as the country is hit by an outbreak of the new coronavirus, February 3, 2020.

Jason Lee | Reuters

BEIJING – The U.S. Federal Reserve's emergency interest rate cut gives China's central bank much more leeway to lower its own rates, and boost the internationalization of the yuan, analysts said. 

In response to concerns about the new coronavirus' economic impact, the Fed surprised markets during the New York trading session on Tuesday with a half percentage-point rate cut. It came two weeks before a scheduled meeting. The last time the Fed took similar emergency action was during the financial crisis in 2008.

The Fed's loosening of monetary policy will likely accelerate similar moves by the People's Bank of China, said Zhao Bowen, research director at Beijing-based Blue Stone Asset Management. 

"The bottom line is opened more," he said, according to a CNBC translation of his Mandarin-language remarks. But he noted increased fiscal spending is what China will really need to support economic growth. According to his calculations, GDP growth in the second and third quarter must reach at least 7.5% in order for the country to achieve its implied goal of roughly 5.5% for 2020. 

While the timing and exact scale of expected PBOC rate cuts vary, analysts pointed out the Fed's move will keep the Chinese yuan from weakening too much, alleviating concerns about capital outflows, and even boost inflows in the near future. 

That would go a long way toward helping the Chinese government along with its years-long efforts to boost use of the yuan in global financial markets. Also known as the renminbi, the Chinese yuan accounted for 1.65% of global payments by value in January, versus 40% for the U.S. dollar, according to Swift, the financial messaging service for banks.

Boost to yuan-denominated assets

The U.S. dollar index extended recent losses to touch its lowest level since early January, while the yuan reversed a recent weakening trend to strengthen by well over half a percent to near 6.93 per dollar. 

"(For the yuan), yesterday was a turning point," Xu Hongcai, deputy director of the Economics Policy Commission at the China Association of Policy Science, said in a phone interview, according to a CNBC translation of his Mandarin-language remarks. 

"So this shows confidence in China," he said, adding that capital is flowing into the country.

International investors will likely also be more attracted to the relatively higher yields of Chinese yuan-denominated assets if current trends in financial markets and monetary policy persist. 

Yuan-denominated assets were never really considered safe haven, Zhao said. But with expectations that the Fed will cut rates again at its meeting later this month, Treasury yields are likely to fall further, he said, noting investors may begin to question the scale of their U.S. asset holdings.

U.S. Treasury yields fell after the Fed rate cut, with the benchmark 10-year yield hitting a record low of 0.906%. The Chinese equivalent traded near 2.71% on Tuesday. The roughly 180 basis point spread, or gap between yields, makes the yuan-denominated bonds a more attractive investment. 

Given the Fed's rate cut, which some criticize as too hasty, the internationalization of the yuan is being "pushed forward," Zhao said.

As for stocks, the Shanghai Composite gained 0.6% on Wednesday, versus the S&P 500's volatile 2.8% drop overnight. While the mainland Chinese A-shares market has been likened to a casino for years, the Shanghai Composite has kept its fluctuations close to the 3,000 level for much of the last several months. 

Cao Yanghui, deputy director of the Nanhua Futures Research Institute, said the coronavirus' spread in China has entered a more stable period than overseas. 

"Relative to overseas markets, domestic assets have begun to have some properties of safe-haven assets," Cao said, according to a CNBC translation of his Chinese-language statement. "If U.S. stocks continue to decline, A-shares will not necessarily follow, and may even begin an independent upward trend."

Calls for more coordination

Shortly before the Fed made its emergency move, financial leaders from the G-7 major economies released a vague statement on working together to fight the coronavirus. The central bank of Australia had already cut rates, while the European Central Bank and other major central banks are widely expected to follow suit in the coming weeks. 

"Because of this situation, the whole world needs to strengthen monetary policy coordination," Zong Liang, chief researcher at the Bank of China said in a phone interview, according to CNBC's translation of his Mandarin-language remarks.

That includes exchange rates, he said. Zong added that large-scale rate cuts are not needed at this time, and China would hope to direct global rates toward a stable level, with space for additional monetary policy action. 

Further cuts would take interest rates that are already at unprecedented lows or negative territory even lower. China has kept rates at a relatively higher level, while facing unique challenges in getting the local economy to truly reflect the benefits of lower rates.

For now, the situation at home is still key for each country, especially for China.

"I don't think they have the bandwidth to think about more than stability," said James Early, CEO of investment research firm Stansberry China.

"I think the (PBOC) sees (the Fed cut) as a negative because it signals meaningful concern from the world's largest economy," he said. "They couldn't even wait two weeks. The information that was communicated was fear and the PBOC has to digest this." 

The Chinese central bank did not immediately respond to CNBC's request for comment.

On Tuesday, China's central bank held a meeting with other major financial regulators and institutions in the country to discuss recently announced support measures, and lowering financing costs amid the virus' impact to the economy. It was unclear according to the official announcement if the meeting ended before the Fed announced its rate cut late that night Beijing time.