Jahangir Aziz, Head of EM Economics Research at JPMorgan, and Luis Oganes, Head of Global Macro Research at JPMorgan, discuss China’s disinflation and slowdown, Fed rate cuts, Bank of Japan (BoJ) hikes, the yen carry trade, and more in an exclusive interaction with CNBC-TV18.
These are the verbatim excerpts of the interview.
Q: Was this big announcement from China more than expected, this 20 basis rate cut, and promises of more cuts? What does it do to the Chinese economy?
Aziz: Those are two separate questions. The first question is, was it expected? It was more or less expected. But you have to look at the two of them separately. The 50 basis points of reserve ratio requirements (RRR) cut was meant to create enough liquidity for the Chinese government to continue to issue bonds because that was the that was basis in which we had called for a 50 basis points of rate cut. The 0.2% cut got a repo cut that was tied higher than what we had. We had 10 basis points of cut. But again the amounts and the timing of that was always quite uncertain.
Clearly, as you pointed out in the introduction the Fed cut of 50 basis points is having an impact on Asia. Asia was the place where you did not have enough amount of cushion and that was where the concern was that these countries or these central banks could not cut without triggering concerns about financial stability. I think the rate cut by the Fed has opened that space and you will see other central banks follow. So I think that the overall idea that the Fed, intransigency over its rate-cutting cycle and making us wait for quite some time was holding back the central banks in Asia particularly, not in Latin America or other places. It is playing out to be true.
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Q: Before you analyse the impact on the Chinese economy, which we are all terribly interested, just to complete the argument, does this make it more incumbent on the Reserve Bank to act, at least from the currency angle because if there are so many cuts and the Chinese central bank also cuts a rupee appreciation will be uncomfortable.
Aziz: So I wouldn’t bring foreign exchange (FX) directly into it because obviously, RBI has a very ambivalent attitude towards what it does to the rupee insisting that it only smoothens out volatility. Clearly they have a view about where the rupee goes but I would say that it’s much more domestic-driven, the need for RBI to cut. So if you have an economy and let us not go into what recorded growth is or not growth is. Let us look at the proof of the pudding.
The proof of the pudding is core inflation and core inflation today is at its lowest level since the inception of the index in 2012. It has been falling over the last nine 10 months, I have lost count of that. In any country where core inflation has fallen to this low level and it has been actually falling on a sustained basis it always smells of serious excess capacity in the economy and not only excess capacity but widening excess capacity.
You can have core inflation falling one month and then go back at other and then you can say, well, it’s something else that was working. But 9-10 straight months to its lowest level in 2012, so I think that it is incumbent on the RBI, just like the Fed does, Fed did, which is that we need to recalibrate.
Q: You are calling for a December cut or an October cut itself?
Aziz: So my India team does not have an October cut. They say that in October they will change their language and then there will be December cut. I am probably on the side that why change the language only if this was a 25 basis point of cut by the Fed then I would say change the language and then go for a December cut it’s a 50 basis point of rate cut.
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Q: Do you think the Chinese disinflation recedes somewhat if the rate cut recharges that economy?
Oganes: I don’t think that that is going to recede anytime soon, because the problem is that China has a problem of excess supply right now because there is not sufficient domestic demand. There is still a problem in the real estate sector, which demands a lot of steel, to your point, or other commodities. The solutions to that are not anywhere to be seen.
We know from experience of any country that has had a boom-bust cycle in the real estate market, it takes time for this clean up to happen. So what China is doing is, obviously keeps manufacturing and keeps flooding the global economy, global markets with its cheaper production. That has been generating a lot of reactions, right? US, Canada, EU you name it, imposing restrictions, some tariffs, or protesting this attitude. But China is not — they see it to their benefit. So I think that this is this inflationary impulse from China, in my mind, is going to continue.
Q: Where is the Yen headed and is there a chance of a repeat of the yen carry trade unwind, which hit us in early August or these things don’t repeat, because the world is prepared”
Oganes: The projection that we have is that the yen is going to be potentially crossing Pearson again at that 140 level, going to the high 130s, but this assumes a US going into a soft landing, and nothing dramatic happening around the US elections. If we get a US recession scenario, it is possible that we get more rate cuts by the Fed. It is possible we will get to the low 130s or even the high 120s. This is clearly not in the market.
As Jahangir said, our team expects more hikes than what the market is discounting right now. So, if you speak to JP Morgan traders, a dollar-yen is a currency, so the yen is a currency that they seem to favour, just because it is still not consensus. People are not convinced that these inflation dynamics are here to stay, that the policy path for the BOJ is for more hikes. This is still, not everyone is believing it.
For full interview, watch accompanying video