Fed action may boost A-share liquidity

Amid rising anticipation that the U.S. Federal Reserve will cut interest rates within the week, Chinese shares are likely to see improved liquidity in the short term while a long-term and sustainable rebound is still dependent on companies' improving fundamentals, said experts.

While major central banks — including the Bank of England and Bank of Japan — will announce their monetary policies this week, all eyes are on the Fed, which is likely to cut rates for the first time since March 2020.

Odds are high for the Fed to usher in an interest rate cut cycle early Thursday (Beijing time), but the size of the cut is still a coin toss, Yi Huan, chief macroeconomist at Huatai Securities, wrote in a report on Monday.

Possible options include either lowering the interest rate by 50 basis points, or announcing a 25bp cut combined with a clear dovish forecast guidance. The former has a slightly higher probability, said Yi, adding that the Fed may cut interest rates by over 100bp by the end of the year.

According to FedWatch, a forecasting tool from financial services provider CME Group, there is now a 63 percent chance that the Fed will announce a 50bp cut, up from 30 percent one week ago.

Michael Feroli, JPMorgan's chief U.S. economist, wrote in a note on Friday that cutting the policy rate by 50bp is the "right" thing to do.

But Ipek Ozkardeskaya, senior analyst at Swissquote Bank, said that a 25bp cut would be appropriate to start with, as inflation is cooling and U.S. corporate earnings were robust for the past quarter.

The U.S. GDP tallied a 3-percent growth in the second quarter and the Atlanta Fed's GDPNow forecast suggests that third quarter growth will likely be above 2 percent. The U.S. labor market is cooling, but does not look alarming, she added, implying that a 25bp cut would be adequate.

For the Chinese market, how domestic policies will respond to the loosening external market is the major topic for closer scrutiny vis-a-vis the Fed's expected interest rate cut, according to experts from China International Capital Corp Ltd.

If more relaxed policies are adopted in China, the market will be boosted. The Fed's cut will open up more room for the Chinese central bank. But relaxation will be limited and strong stimulus may not be opted for, they added.

Once the Fed cuts rates, A-share liquidity will be lifted in the short term as pressure on the RMB's foreign exchange rate will be alleviated, opening up room for China's monetary policy, said Wu Xinkun, chief strategist at Haitong Securities.

Foreign capital may also flow back into the A-share market over the short run, also improving A-share liquidity at the micro level. Public financial service providers as well as food and beverage companies may benefit in such a scenario, said Wu.

But the medium to long-term performance of A-shares is determined by company fundamentals. If successive supportive economic policies can help propel China's economic recovery, an upward momentum will be more firmly baked into the A-share market, benefiting Chinese technology companies and manufacturers with more comparative advantages, he added.

The Hong Kong bourse, which is more sensitive to external liquidity, will exhibit greater elasticity than A-shares in anticipation of the Fed's cut, especially because the Hong Kong dollar is pegged to the greenback, said analysts from CICC.

Therefore, Hong Kong-listed biotech companies and tech hardware firms — which are more interest rate sensitive — as well as sectors receiving more overseas U.S. dollar-denominated financing, and export companies, may marginally benefit from the lowered interest rates in the U.S., said CICC experts.

The Hang Seng Index in Hong Kong closed 1.32 percent higher on Tuesday, while the A-share market was closed for the Mid-Autumn Festival.