MLC: China’s “normal” interest rates boost investment certainty

A more consistent environment for global asset prices and investment is being forged by China’s more “normal” interest rate approach, while other central banks dither over when to call an end to the era of zero-bound interest rates and QE.

That’s according to MLC Asset Management CIO Jonathan Armitage, who made these points in a recent note to investors.  

False start

Central banks were ready, locked and loaded. The time for change was nigh.

The US Federal Reserve announced a US$15 billion a month reduction, while here at home the RBA gave up buying the April 2024 government bonds with which it had been suppressing rates.

For their part, South Korea, Brazil, and Mexico, Norway, and New Zealand had already raised rates.

Then along came Omicron.

“In terms of the economic and market impacts of Omicron; greater economic uncertainty probably pushes back the timing of interest rate increases, which looked like they were being brought forward based on central bank actions and changes in language before the latest events,” said Armitage.

Interest rate uncertainty has led to asset price uncertainty.

“... on balance, another wave, should it eventuate, would probably be more inflationary than deflationary, which would be negative for fixed income assets, and mixed for shares," he said.

“The chances of getting assessments right at this stage remain problematic, so diversification and risk management are key.”

In any case, Armitage believes the low-rate environment to which we’ve grown so accustomed is anything but normal.

“The prolonged low interest rates of the post GFC era may have conditioned us to think of them as normal, but from an orthodox economic perspective there is nothing normal about official interest rates hovering near zero," he said.

"It suggests something is very amiss across advanced countries that interest rates have stayed so low for so long.”

China's normal rates

China, on the other hand, is a country where "normal" interest rates have “prevailed and worked,” even during global economic crises.

“In January 2009, the 1-year Working Capital rate set by the People’s Bank of China was 5.31% and stood at 4.35% recently. On the other hand, official interest rates in the US, the Eurozone, and the UK were 0.13%, 2% and 1.5% respectively in January 2009, and 0.13%, 0% and 0.1% at the end of November this year," said Armitage.

To be sure, China’s situation is unique. And Armitage acknowledges this.

“China is a middle-income country, at least on income per head measures, so critics could say that like-for-like comparisons with wealthy countries’ interest rates are unreasonable," he said.

“Moreover, neither is China democratic or capitalistic.”

So, how has China been able to maintain a normal rate environment while the rest of the world maintains rates at next to nothing?

“The short answer is that interest rate policy in China has continued to work, as it’s meant to," Armitage said.
"Higher interest rates have dampened economic activity, while lower interest rates have spurred activity. There’s been no need to go to zero interest rates just to keep the economy from coming to a standstill, as has been the case with many advanced economies.”

Armitage further argues that a normal rate environment in China has been possible thanks to a tailored approach to the way it throttles its economy.

“Chinese interest rate exceptionalism has worked because Beijing allows the national policy to take local conditions into consideration. It’s not one-size-fits-all monetary policy.”

Rather, China sets the interest rate centrally but applies monetary policy locally, fuelling sluggish parts of the economy while cooling those that may be overheating.

“While bustling new economic hot zones such as Hainan are restricting lending and inhibiting liquidity, stagnant markets such as Zhuhai are relaxing liquidity and supporting prices,” explains Armitage.

“The dual-track approach also means that while the government is pulling the reins on large state-owned enterprises and property developers that previously gorged on easily accessible credit, or striking out at high-profile technology companies, it’s rolled out supportive policies for small to medium-sized enterprises ranging from access to credit, through to taxation and support for employees.”

What does this mean for investors?

For an asset manager like MLC, normal interest rates provide a more tempered and consistent environment for asset prices to perform.

“We have been expressing this positive view for some time through Chinese shares and bond positions within the MLC Inflation Plus portfolios, and more recently in the MLC Horizon portfolios through an overweight allocation to emerging market shares,” Armitage said.

“Moreover, these positions are customised to achieve a targeted exposure to the Chinese assets that we believe will benefit most from government policy settings.”

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