China’s asset prices continue to diverge from global trends, with the benchmark index falling below 2800 points and continuing its downward trajectory. This Friday saw another sharp pullback, and government bond prices have surged past previous highs. The central bank’s short-selling strategy has failed to alter the market’s direction. Investor enthusiasm for fixed-income assets remains strong, as expectations form gradually and then accelerate. If macroeconomic policy falls short, it will exacerbate market speculation on the effectiveness of policy interventions. Currently, China’s financial markets are undergoing rapid shifts, with risk aversion climbing sharply. The three key asset classes—government bonds rising, equities declining, and the property market weakening—are moving in unison. Such one-sided asset price movements pose a significant threat to financial stability. If expectations repeatedly fall short, reversing market sentiment will require greater effort. At the heart of this issue is the debate around the flexibility of China’s monetary policy.
Macroeconomic Environment: The focus of macro policy is on stimulating consumption. Of the ¥1 trillion special government bonds, ¥150 billion has been allocated for equipment upgrades and another ¥150 billion for stimulating consumption. Estimates suggest that the ¥150 billion, coupled with a 20% subsidy as implemented in cities like Beijing and Guangzhou, could generate ¥750 billion in sales—similar to the ¥740 billion seen during the 618 Shopping Festival. However, inflation expectations are key: if consumers anticipate future price declines, the effectiveness of subsidy policies will be limited. The impact of these measures will likely be reflected in retail data for September and October. Investment data remains murky, with reports indicating that nearly ¥1 trillion has been funneled into strategic emerging industries via state-owned enterprises. On the trade front, export performance continues to suffer from the ongoing trade tensions. The upcoming Mid-Autumn and National Day holidays will provide crucial consumer data, with per capita spending being a key metric to monitor.
Monetary Policy: The People’s Bank of China withdrew ¥1 trillion from the open market this week, yet market interest rates continue to fall. Market risk preferences are evolving rapidly. On one hand, monetary policy aims to maintain a positive interest rate curve to support bank profitability and ensure financial stability. On the other hand, there is a political mandate to lower financing costs for the real economy. These two objectives are increasingly at odds, with market participants adopting a wait-and-see approach. Bank deposits are flowing into wealth management products, flattening the interest rate differential between deposit rates and market rates. The more the central bank tries to preserve this differential, the faster deposits will shift, as falling deposit rates push savers towards market investments. This exerts downward pressure on the entire yield curve. The momentum behind rising government bond prices is further amplified by leveraged capital. While short-term measures like short-selling government bonds can be used to control this behavior, in the long run, it reflects market expectations of future rate cuts by the central bank.
According to the latest monetary policy statements, the central bank aims to reduce financing costs for the real economy without shrinking the net interest margins of banks. This limits the room for Loan Prime Rate (LPR) cuts to around 50 basis points. To widen this space, deposit rates would need to be lowered, which in turn would accelerate the shift of funds into other markets, further compressing market interest rates. This 50-basis-point window may be the only available space for policy maneuvering. The central bank has indicated that it may inject liquidity through reserve requirement ratio (RRR) cuts, but this seems impractical. With ¥1 trillion being withdrawn via reverse repos and another ¥1 trillion being released through RRR cuts, the net effect would be negligible. Moreover, this 50-basis-point room is constrained by housing loans.
Housing Market and Mortgages: The May 17th policy canceled the lower bound on mortgage rates and reduced rates on public housing fund loans. In key cities, new mortgage rates have already fallen into the 2% range. Throughout 2023, as LPR rates rapidly declined, to avoid a large disparity between existing and new mortgage rates, macro policy required commercial banks to renegotiate the rates on existing mortgages. However, this adjustment is staggered annually, and many existing mortgage rates remain around 4%. This creates a significant gap between old and new mortgage rates. For existing mortgage holders paying 4%, there are few investment options that can offset such costs, leading many to opt for early repayment. This accelerates the disappearance of money from the economy, with billions vanishing each month. From a modern monetary theory perspective, this money is effectively being withdrawn from the economic system, putting downward pressure on asset prices. Any further optimization of housing policies would only accelerate this trend of early repayment. The sheer scale of liquidity being drained—billions disappearing monthly—presents a contractionary force that few monetary policies can counteract.
Thus, addressing the issue of existing mortgage rates is a significant macroeconomic challenge, and not just about banks sacrificing profits. There are two main strategies the market is speculating on: one is a continuation of the 2023 approach, renegotiating mortgage contracts to reduce rates from 4% to 2%. The second is mortgage refinancing. In simple terms, this would allow mortgage rates to be automatically reduced when properties are sold. For example, when a property is sold from owner A to buyer B, the existing mortgage rate on that property—currently at 4%—would automatically drop to 2% when transferred to B. If implemented, the 2% rate difference would be distributed between A and B, leading to a decline in second-hand property prices and accelerating the absorption of existing housing stock. This process would not only prevent the disappearance of currency but also boost activity in the second-hand housing market, making it easier for people to upgrade their homes. The main obstacles to this policy would be a reduction in bank profits and increased complexity in managing such transactions.