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Analysis

Asia wrap: The PBoC greases the wheels

US stocks are trading sharply higher alongside bonds as yields on 10-year Treasury bonds are down 15bp in the wake of a surprisingly benign CPI inflation release further suggesting that the 'hard part' for the Fed hiking cycle is behind it. The next move for rates may more likely be down than up.

The October CPI release came in well below expectations, with month-over-month core CPI inflation falling to 0.23% from 0.32% a month earlier - and the year-over-year rate decelerated by 10bp to 4.0%

The move lower in October inflation also comes on the heels of last Friday's surprising spike in inflation expectations as captured by the University of Michigan's Consumer Sentiment survey. But the rise in inflation expectations from higher gas price expectations is presumably driven by concern about war in the Middle East -- a development that has not caused gasoline prices to spike yet.

On the back of the lower inflation (and rates) data, stocks are characteristically moving higher -- and stocks that should benefit from rate relief are doing particularly well. Real Estate and Utilities are among the best-performing sectors. Mega-cap Tech -- the 7 stocks that make up about 25% of the S&P 500 market cap -- is also outperforming mostly as investors lean into long-duration assets as longer-term rates recede. Five of the 7 FANGMAT stocks are outperforming today.

Which brings us to the downside of receding inflation: whither growth? To be sure, the spike in inflation that first emerged in the summer of 2021 does now appear to have been transitory -- driven by a variety of post-pandemic anomalies including stimulus, pent-up demand, supply chain disruptions and how people thought about work. Diminishing inflation -- while welcomed -- may also be a sign that the post-pandemic era is evolving further and the unusual demand boosts of the past 3 years are starting to fade.

Asia markets

China's consumer and industrial activity outpaced expectations in October, providing optimism for improvement amid challenges such as a property market slowdown, weak trade, and ongoing recovery efforts from the COVID-19 pandemic.

The PBoC continues to grease the wheels. The People's Bank of China (PBOC) has injected a net CNY600 billion into the economy, despite leaving the 1-year medium-term lending facility (1Y MLF) at a rate of 2.5%. Analysts believe that this move is aimed at supporting stimulus spending, and it also raises the possibility that the PBOC may consider other policy tools, such as required reserves, in the future.

Ahead of the monthly deluge of activity data, the People's Bank of China (PBOC) provided markets with a positive surprise. Despite leaving the 1-year medium-term lending facility (1Y MLF) rate at 2.5%, the PBoC injected CNY1.45 trillion in funding, a net CNY600 billion more than that which was falling due for rollover. The MLF is the conduit through which the PBoC lends funds to big commercial banks, who, in turn, finance the rest of the economy.

Since September, short-term market interest rates have increased due to the weakening of the CNY against the stronger USD. To prevent CNY selling, the PBOC has maintained high short-term funding costs. However, this has led to a liquidity shortage. To address this issue, the PBoC is now considering volume lending as an alternative to the current rate environment.

The government is considering implementing policies to improve liquidity, such as lowering the rate of required reserves (RRR). This move aims to stimulate economic activity without resorting to large direct fiscal stimulus measures or rate cuts, which could lead to the devaluation of the CNY. The last RRR cut occurred in September when the rate for banks was lowered by 0.25%.

China has faced a series of disappointing economic data this year, encompassing weaknesses in trade, manufacturing, foreign direct investment, and a slowdown in the property sector, intensifying concerns despite the lifting of pandemic restrictions in January. Still, the latest indicators, published on Wednesday, paint a mixed picture, with fixed-asset investment falling below expectations, growing by only 2.9% in the year to October compared to 3.1% in the year to September.

Oil markets

Crude oil futures experienced an uptick in trading on Wednesday morning following positive industrial production and retail numbers from China, which contributed to improved market sentiment. Worries about China demand have been a major point of concern for oil traders and the relatively upbeat economic prints should alleviate some of those concerns

Forex markets

Most Asian currencies strengthened on Wednesday, while the dollar remained at over two-month lows. Weaker-than-expected U.S. inflation data led to speculation that the Federal Reserve might be finished with interest rate hikes. Positive economic data and a substantial 600 billion yuan ($83 billion) liquidity injection by the People's Bank of China further improved sentiment, along with signs of resilience in Asia's largest economy.

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