What’s the Impact of the Fed Interest Rate Cut on the Chinese Investment Market?

Written by Ziyi Ling

On September 18th, the Federal Reserve announced at the Federal Open Market Committee meeting that they would lower the interest rate by 50 basis points to a target of 4.75% to 5% (Morgan, 2024). Over the past 20 years, the interest rate in the United States remained high at approximately 5.3% (Sheng, 2024). Chair Jerome Powell said that this decrease in interest rate aims to “restore price stability without the kind of painful increase in unemployment that has come sometimes with this inflation” (Cox, 2024). As the biggest economic body in the world and the center of the global financial universe, the United States’ economic policy is likely to impact central banks’ decisions in other countries as well. The following essay will briefly introduce the economic theories of interest rate adjustment and focus on the impact of this U.S. interest rate cut on China’s investment market: stock and bonds.

The interest rate is an essential monetary tool for the Federal Reserve to stabilize the economy. Interest rate adjustments have huge economic impacts from several angles: personal consumption, investment, exports to foreign markets, the market currency exchange rate, and more. Interest rates can be considered as the cost of borrowing and the opportunity cost of investment. When the interest rate is high, individuals are discouraged from borrowing from the bank due to the expensive interest to be paid associated with this borrowing. As a result, the individual consumption level is also relatively lower compared to a low-interest rate period. Similarly, investment, the significant component of aggregate demand (or GDP, in other words), is likely to be low during a high-interest rate period as well. A high interest rate means that the return on savings is also higher, which may incentivize individuals to invest less and save more. After all, investments are all risky, but savings in the bank guarantee a positive fixed return. The vice versa is also true with a lower interest rate, where the low interest rate increases individual consumption and investment level. Besides impacts on the domestic market, changes in interest rates also have significant implications on the foreign exchange and export market. A higher interest rate is more attractive for foreign investors as it implies a greater return on their investment, leading to an increase in demand for money and thus resulting in currency appreciation (Calimanu, 2023). Following this appreciation, exports from the country become less attractive as they are more expensive for foreign customers, and imports from other countries are considered cheaper for domestic buyers. As a result, the net export may fall. 

Bearing these economics theories in mind, how did the United States’ interest rate cut impact China and specifically the Chinese stock market? To answer this question, it is important to learn about the Chinese Central Bank’s response first. 

A week after the Federal Reserve announced the interest rate cut, the Central Bank of China reduced the seven-day reverse repo rate from 1.7% to 1.5% in late September (Bradsher). In addition, China has cut its key policy rates and standing lending facility rates by 20 basis points (Stillpass and Wynne, 2024). China’s timely response is linked to its declining

economic performance over the past few years. Property value has fallen around 10% per year over the past three years (Bradsher, 2024). Housing is significant to the Chinese economy as it accounts for 30% of the GDP and 70% of the household wealth (Sheng, 2024). However, before the announcement of the interest rate cut in the United States, the Central Bank of China did not lower the interest rate substantially to stimulate the economy for fear of capital flight. Therefore, the United States’s interest rate cut allows China to revive its domestic economy and investment market. 

Since the rate cut (50 basis points) in the US this time is larger than the rate cut (20 basis points) in China, some capital may flow into the Chinese stock market, which will help increase the supply of funds to the stock market and increase the transactions in the market. This then drives up stock prices and stimulates short term market growth (Zhang, 2024). However, it is also worth noting that capital inflows are volatile based on historical precedents (Yu, 2024). Therefore, how long this growth can be sustained is still debatable. In addition, the financing costs for enterprises in China may be lower due to the interest rate cut, which is especially beneficial for enterprises that rely heavily on external financing. This helps to improve corporate profitability and performance, thus enhancing investor confidence in the stock market and driving up stock market valuations (Zhang, 2024). The benefits brought to the Chinese stock market by the expansionary policy from the United States and China are evident. China’s stock market (CSI 300) jumped 14.9% on September 27thto a sixteen-year high (Bradsher, 2024). The Heng Sheng index in Hong Kong, which is often considered volatile, also increased by 12.9% by the end of September. 

For the bonds market, a lower interest rate is associated with a fall in the yield but a rise in the price (PIMCO, 2023). This means that the older bonds are now paying investors a higher interest rate than the newer bonds, therefore, the price of the bond rises. Moreover, the Fed’s interest rate cut provided the Chinese central bank with more monetary policy operations (Zhang, 2024). China’s central bank may take corresponding monetary policy measures, such as lowering interest rates and increasing money supply based on the domestic economic situation, which are favorable to the development of the bond market and may further drive bond prices up. 

There are also some potential negative impacts on the Chinese stock market due to negligible policy. The depreciation of the U.S. dollar compared to the Chinese currency RMB may create pressure on the Chinese export industry, where firms find themselves less competitive in terms of price in the international market. This may, in turn, lead to increasing pressure on the revenue of exporters, which in turn may affect the stock price of those firms (Zhang, 2024). In the short term, changes in market expectations may lead to increased volatility in the stock market. Investors may overreact to changes in various factors, thus triggering large stock market shocks.

For the bond market, expansionary monetary policy exerts inflationary pressure on the economy. To correct that, the central bank may take contractionary measures, which will lower the prices of bonds in the future. In addition, investors may need to reinvest money earned from the matured bonds in new bonds that pay a lower return due to the cut in interest rates, potentially lowering the long-term return (PIMCO, 2023). 

In conclusion, the U.S. interest rate cuts affected the monetary policy adopted by China, which has affected the investment market. However, the impact created by this change is complex and it is uncertain whether the stock market will get better as the short-term improvement predicted or whether there will be significant turbulence after a short period of improvement in the future. Changes in the bond market will have different impacts on different buyers as well. The issue, therefore, is worth investigating further and more research can be done in the future.

References

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Bradsher, K. (2024a, September 24). China cuts interest rates and mortgage down payments. The New York Times. http://www.nytimes.com/2024/09/24/business/china-cuts-mortgage-rates.html

Bradsher, K. (2024b, September 27). China stocks soar in biggest single-week jump since 2008. The New York Times. http://www.nytimes.com/2024/09/27/business/asia-stocks-csi-300.html

Calimanu, S. (2023, September 21). How rising interest rates impact foreign direct investment. ResearchFDI. https://researchfdi.com/resources/articles/how-rising-interest-rates-impact-foreign-direct-investment/  

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