CICC interprets the financial combination, convenient swaps may lead to the central bank expanding its balance sheet

CICC Research

On September 24th, the State Council Information Office held a press conference to introduce the relevant situation of financial support for high-quality economic development, announcing a series of proactive monetary and financial policies [1], including:

1. Lowering the reserve requirement ratio by 0.5%, releasing approximately RMB 1 trillion in long-term liquidity. 2) Reducing the 7-day reverse repurchase rate from 1.7% to 1.5%. 3) Lowering the interest rates on existing housing loans and unifying the down payment ratio for housing loans, guiding commercial banks to lower existing housing loan rates to the level of new loan rates, with an expected average decrease of about 0.5%. 4) Supporting eligible securities, funds, and insurance companies to obtain liquidity from the central bank through asset pledging. 5) Establishing a special refinancing facility for stock repurchases to guide banks to provide loans to support listed companies and shareholders in repurchasing and increasing their holdings of stocks.

Looking ahead, what are the trends in macroeconomics and policies? What impact will they have on various assets? Please listen to the joint interpretation by CICC's macro team and industry experts.

Macro

Financial Efforts Await Fiscal Boost

On the morning of September 24th, the State Council Information Office held a press conference on the relevant situation of financial support for high-quality economic development [2]. Interest rate cuts and adjustments to refinancing policies have effectively reduced the debt burden of the real economy, alleviating potential cash flow risks. We believe that the reduction in the reserve requirement ratio not only meets the current funding needs for credit expansion and existing fiscal efforts, but may also be used in part to replace MLF, or to prepare for potential fiscal efforts.

The central bank has introduced structural monetary policy tools for supporting the stock market. Among them, the possibility of swap facilities may lead to an expansion of the central bank's balance sheet, and different ways of expanding the balance sheet have different impacts on the base money. Without base money injection, swap facilities may affect the prices of stocks and bonds through asset rebalancing effects.

The adjustment of monetary policy, combined with financial regulatory and capital market reform measures, has already had a positive impact on market expectations. If subsequent fiscal policies can expand significantly and the direction of expenditure can be more efficient, confidence in the real economy will be further boosted. In the second half of the financial cycle, fiscal expansion is very important for boosting growth and alleviating financial risks, with the recent necessity significantly increasing.

The comprehensive interest rate cut this time will reduce the interest burden on the real economy by about RMB 690 billion (annualized), and the total interest burden for the year may decrease by about RMB 1.3 trillion (annualized, around 1% of GDP). The central bank's reduction of the 7-day reverse repurchase rate by 20 basis points this time is likely to be followed by a 20 basis point reduction in the 1-year and 5-year LPR in October. We estimate that this will save the real economy about RMB 500 billion (annualized) in interest burden.

In addition to the LPR reduction, the expected adjustment in the markup of existing housing loan rates is expected to drive a 50 basis point decrease in existing housing loan rates, reducing the interest burden on the real economy by about RMB 150 billion (annualized). Taking into account the previous rate cuts, the 5-year LPR is expected to cumulatively decrease by 55 basis points by 2024, and the 1-year LPR is expected to decrease by 30 basis points, marking the largest adjustment since 2020 We estimate that the LPR cut in 2024 will save the real economy a burden of around 1.1 trillion yuan (annualized), plus an additional 150 billion yuan saved from the reduction in loan interest rates for existing housing loans. The total reduction in interest burden for the real sector in 2024 is approximately 1.3 trillion yuan (annualized), equivalent to around 1% of GDP, with most of it likely to take effect starting in the first quarter of next year.

The pressure of principal repayment has been on the rise in recent years, and the policy of loan renewal helps substantially reduce cash flow risks, which is of great significance. According to our calculations, the increasing pressure on non-governmental sectors in China in recent years comes more from principal repayment pressure, while interest payment pressure remains relatively stable. Based on calculations from the annual reports of listed and bond-issuing banks, the proportion of loans maturing in the next 12 months to GDP has reached a relatively high level.

The China Banking and Insurance Regulatory Commission has optimized the policy of loan renewal from three aspects, significantly expanding support for small and micro enterprises, extending the stage-wise renewal support to medium-sized enterprises, and not downgrading the risk classification of eligible renewals due to extension alone, which significantly alleviates cash flow risks caused by debt maturity.

The reduction in reserve requirements not only meets the current needs of credit expansion and existing fiscal efforts but may also be used in part to replace MLF, or to prepare for potential fiscal efforts. This time, the reduction in reserve requirements reached 50 basis points, releasing long-term liquidity of 1 trillion yuan, and Governor Pan Gongsheng also stated that there may be another reduction of 25-50 basis points later this year, potentially releasing an additional 500 billion to 1 trillion yuan of liquidity. In February of this year, there was already a 50 basis point reduction in reserve requirements, releasing around 1 trillion yuan of liquidity. Adding up these amounts, the total liquidity released from reserve requirement reductions this year may reach 3 trillion yuan.

Considering the current pace of expansion of bank balance sheets, assuming that the balance of MLF and other open market operations remains relatively unchanged, a liquidity scale of 3 trillion yuan may not only cover the liquidity needed for financial institutions' credit expansion and existing fiscal financing plans. We believe that some of the funds released from the reserve requirement reduction may be used to replace MLF or to hedge against the recent repurchase of MLF, and there is also the possibility of preparing for potential fiscal or quasi-fiscal efforts.

Governor Pan Gongsheng also explicitly stated at the meeting, "The level of government bond yields is the result of market forces, and the People's Bank of China respects the role of the market, creating a good monetary environment for implementing proactive fiscal policies."

The People's Bank of China has created structural monetary policy tools for supporting the stock market and indicated that the quota can be increased in the future. This time, the central bank has created two monetary policy tools to support the capital market, the first being the convenience of swaps between securities, funds, and insurance companies, and the second being stock repurchase and increased re-lending. The central bank not only stated that there is no specific limit on the quota this time but also mentioned that the state-owned capital management fund is under study, providing confidence to the capital market in the general direction. In terms of specific operations, the profit and loss risks of swaps and stock repurchase and re-lending are borne by financial institutions or borrowers themselves, with the central bank providing liquidity support From the perspective of convenience exchange, securities, funds, and insurance companies can pledge bonds, stock ETFs, and constituents of the SSE 300 Index, and obtain treasury bonds after the pledge. After obtaining liquid assets such as treasury bonds, financial institutions should be able to choose to obtain funds through treasury bond pledging or trading, with the related funds only being used for stock market investments. This trading chain may involve two rounds of asset conversion (one with the central bank's asset swap, and the other with market participants' pledging or trading), and the details of these two processes need further clarification.

The impact of convenience exchange on the central bank's balance sheet and base currency is more complex: Convenience exchange may lead to the central bank expanding its balance sheet (by issuing central bank bills or purchasing treasury bonds in the secondary market), and the central bank's purchase of treasury bonds in the secondary market will result in base currency injection. After accepting assets from financial institutions, the central bank will provide central bank bills or treasury bonds to the financial institutions.

There are three scenarios: 1) If the central bank exchanges central bank bills with financial institutions, the central bank expands its balance sheet but the base currency remains unchanged; 2) If the central bank needs to increase treasury bond purchases in the secondary market for the exchange, the central bank expands its balance sheet and injects base currency; 3) If the central bank exchanges existing treasury bonds with financial institutions, the central bank does not expand its balance sheet or increase base currency. Considering that the central bank still holds RMB 2 trillion in treasury bonds on its balance sheet, and the central bank also has the option to issue central bank bills, convenience exchange may not increase base currency injection in the short term.

If there is no base currency injection, convenience exchange may affect the prices of stocks and bonds through asset rebalancing effects. The central bank can guide financial institutions to actively engage in exchange by setting the exchange price, such as setting a lower exchange rate or a longer exchange period.

For example, if the exchange rate is low enough, the exchange period is long enough, and the dividend yield of stock assets is significantly higher than the exchange rate, after weighing the price risks, financial institutions may engage in exchange operations and invest in the stock market. The result of convenience exchange is a reduction in the supply of risky assets in the market (pledged to the central bank and cannot be sold), while the supply of safe assets (such as treasury bonds or central bank bills) increases.

Assuming that the proportion of safe assets to risky assets held by all financial institutions is already at an acceptable level, after the exchange occurs, the weight of safe assets held by financial institutions increases and the weight of risky assets decreases. This result incentivizes financial institutions to rebalance their assets, causing the value of risky assets to rise and the value of safe assets to fall. The change in value brings the weights of safe and risky assets back to an acceptable level for financial institutions.

Regarding the adjustment of real estate market policies such as down payment ratios and refinancing policies, and the indication of support for land acquisition, the overall principle still adheres to marketization. In addition to the adjustment of interest rates for existing housing loans, this round of real estate policies includes four other adjustments, including unifying the minimum down payment ratio for commercial individual housing loans nationwide to 15% (the same for first-time and second-time homebuyers);

Increasing the proportion of People's Bank of China's contribution in the refinancing policy for affordable housing from 60% to 100%; allowing policy banks and commercial banks to provide loans to support conditional corporate market acquisitions of land from real estate companies; extending the policy for refinancing of real estate companies and operating property loans until December 31, 2026. These policies continue to alleviate liquidity constraints from both the demand and supply sides, especially if land acquisition is effectively implemented, it will supplement the cash flow of real estate companies Its effectiveness may also be related to the disposable financial resources of the region and the expectations of various entities on the real estate market.

Adjustments in monetary policy, combined with financial regulatory measures and capital market reform, have already had a positive impact on the stock market's expectations. If fiscal expansion is significant and expenditure efficiency improves, market confidence will further increase. In addition to monetary policy, capital market reform measures and financial regulatory measures have also been announced, including increasing Tier 1 capital for 6 large commercial banks, the Securities Regulatory Commission indicating further promotion of mergers and acquisitions of listed companies, and the China Banking and Insurance Regulatory Commission proposing to expand the pilot reform of long-term investment of insurance funds, and so on.

Our macro model shows that the Shanghai Composite Index may have already factored in the downward expectations of short-term growth and funding pressures, and the term spread of 30-year government bonds also seems to indicate that the bond market has factored in more low inflation expectations. This series of policy announcements has improved secondary market expectations. According to our calculations, household net assets have been under pressure overall since 2021, and the burden of non-government debt repayment is on the rise.

Data from the National Bureau of Statistics shows that the income expectation index in the consumer confidence index for June is at a historically low level; data from the People's Bank of China shows that the income confidence index in the second quarter of 2024 in the household survey is also at a historically low level. If fiscal policy is further intensified in the future, and efficiency in investment is also increased, market confidence will further improve, and economic growth will also be effectively boosted.

Strategies

On the morning of September 24th, the State Council Information Office held a press conference (hereinafter referred to as the "State Council Press Conference"), with the Governor of the People's Bank of China, Pan Gongsheng, the Director of the China Banking and Insurance Regulatory Commission, Li Yunze, and the Chairman of the China Securities Regulatory Commission, Wu Qing, attending the meeting and introducing the relevant situation of financial support for high-quality economic development. This meeting has attracted high market attention, with A-share and Hong Kong stock indices soaring. In our outlook for the A-share market in the second half of the year, we believe that the pace of the A-share market in the second half of the year may show a pattern of "stability before rise," released in late August. The performance of A-shares in the second half of the year is first restrained and then rises, stabilizing and rebounding from the middle to late September. Combined with the spirit of this State Council Press Conference, at the current point in time, we believe that the rebound will continue, as follows:

The State Council Press Conference sends positive signals. The key points that investors are concerned about in this State Council Press Conference include:

1. Recently, the reserve requirement ratio will be lowered by 0.5%, releasing long-term liquidity of about 1 trillion yuan. Depending on the market liquidity conditions for the rest of the year, there may be further reductions of 0.25-0.5 percentage points. 2) Lower the 7-day reverse repurchase rate by 0.2 percentage points, from the current 1.7% to 1.5%. 3) Lower the interest rates on existing home loans and unify the down payment ratio for home loans, guiding commercial banks to lower the interest rates on existing home loans to the level of new loans, with an average expected decrease of about 0.5%. 4) Support qualified securities, funds, and insurance companies to obtain liquidity from the central bank through asset pledging, significantly enhancing institutions' funding and stock holding capabilities. 5) Establish a special re-lending facility for stock repurchases and holdings, guiding banks to provide loans to support listed companies and shareholders in repurchasing and holding stocks In terms of the capital market, a series of policies have been proposed to improve investor expectations, including:

2. Policy opinions on introducing medium and long-term funds into the market. 2) Measures to promote mergers and acquisitions, strongly support listed companies in conducting cross-industry mergers and acquisitions with the goal of transformation and upgrading, and acquisitions of unprofitable assets; significantly simplify the review process for listed companies that meet the conditions for restructuring; increase regulatory tolerance for restructuring valuations, performance commitments, etc., based on actual circumstances; greatly simplify the review process and encourage listed companies to strengthen industrial integration. 3) Protect the legitimate rights and interests of small and medium investors, resolutely crack down on illegal activities such as financial fraud and market manipulation. 4) Listed companies should use methods such as dividends and buybacks to reward investors. 5) Long-term companies trading below net asset value should develop plans to enhance value. 6) Guidelines on market value management for listed companies will be issued soon for public opinion. 7) Support China Investment Corporation (CIC) to increase its holdings in the capital market, and so on.

In September, the A-share market turned marginally upward, and the rebound is expected to continue. In our report "September Market Expected to Stabilize Marginally" released at the end of August, we believe that the reasons for the market's change come from three aspects:

1) Expectations of a rate cut in the United States in September have risen, global funds are expected to undergo reallocation, which may benefit Chinese assets. 2) Combining the current economic and market environment, policies to stabilize growth and expectations are expected to be further strengthened. 3) With the end of the interim reporting period, September enters a period of earnings vacuum, with some sectors experiencing temporary relief from fundamental pressures.

On September 18, the Federal Reserve announced a rate cut, starting an easing cycle, with Hong Kong stocks reacting more significantly and A-shares also rebounding; on September 24, the National New Economic Forum clearly released positive signals for stabilizing the economy, the market, and expectations, leading to a significant improvement in investor risk appetite.

The current valuation of the A-share market is already at an extreme position, with the Shanghai and Shenzhen 300 Index forward valuation near historical bottom standard deviation levels, showing significant investment attractiveness horizontally and vertically; trading and behavioral aspects also exhibit common historical characteristics of a bottoming pattern, with the A-share turnover rate calculated based on free float market capitalization around historical bottom levels of around 1.5% (during historical bottom periods, turnover rates were around 1%-2%). Against this backdrop, the appearance of positive policy signals is expected to boost investor sentiment, and while there may be short-term fluctuations after the market surged on September 24, the rebound is expected to continue. The market's trend stabilization still needs to pay attention to changes in the expectations of listed companies' fundamentals in the future.

In terms of allocation, the short-term non-bank and real estate sectors may perform well, while the medium-term focus should be on small and medium-sized companies and growth styles, with high dividend stocks still showing differentiation.

Securities firms and insurance companies directly benefiting from the spirit of the National New Economic Forum may be relatively strong in the short term, leading the way on September 24; during the period of expectation changes, there may be opportunities in the real estate and consumer sectors, but the sustainability will depend on whether the subsequent improvement in fundamental expectations can be sustained; if investor risk appetite rises along with relatively abundant liquidity, small and medium-sized companies and growth styles that have adjusted more since the beginning of the year may perform well in the medium term; banks providing loan support to listed companies and shareholders for buybacks and stock holdings may benefit high dividend companies, but considering the defensive nature of high dividend stocks, there may be differentiated trends during the process of improving risk appetite, with coal leading the way on September 24 in the pro-cyclical sector, while the household appliances and textile and apparel sectors showed slightly weaker performance Benefiting from the positive signals of national policies, A-shares rose significantly today (September 24). The Shanghai Composite Index rose by 4.2%, the CSI 300 rose by 4.3%, and the total daily turnover of A-shares exceeded 970 billion yuan. In terms of style, the growth-oriented ChiNext Index rose by 5.5%, outperforming the broader market, the STAR 50 rose by 3.7%; the small-cap oriented CSI 1000 rose by about 3.9%; and the CSI Dividend Index rose by about 4.5%. Across industries, most sectors saw gains, with food and beverage, non-banking financials, steel, and coal leading the way. Among them, the food and beverage and non-banking financial sectors' industry indices rose by over 6%; while the home appliance, automotive, and real estate sectors saw slightly weaker gains, but still between 1.2% and 2.3%.

Fixed Income

Since the second quarter, the domestic economy's recovery has slowed down month-on-month, with increased uncertainties both internally and externally, and growing pressure to maintain growth. Against this backdrop, the Political Bureau meeting on July 30 proposed "continuing to exert more force in macro policies" and "strengthening countercyclical adjustments" [3]. The comprehensive easing by the central bank this time is also a response to the policy call.

At the same time, the timing of the policy easing coincides with the Federal Reserve's clear shift to rate cuts before the fourth quarter. On one hand, this confirms the easing of external tightening conditions, easing pressure on stabilizing the exchange rate; on the other hand, it can provide a good start for monetary easing in the fourth quarter to support economic recovery.

In terms of specific policies, the series of new easing measures announced by the central bank not only cover total control tools such as policy interest rates, reserve requirement ratios, existing mortgage rates, deposit rates, and down payment ratios for housing loans, but also include the optimization of some existing structural tools and the creation of structural tools to support the stable development of the stock market. This easing of monetary policy will have the following impacts on the bond market, in our view:

Firstly, it is clear that interbank liquidity is expected to remain loose in the fourth quarter. On one hand, the reduction in reserve requirements will effectively alleviate the liability pressure faced by major banks currently. Even if fiscal policy further strengthens, the central bank mentioned that it will conduct further reserve requirement cuts as needed, indicating a clear stance on safeguarding the funding environment.

On the other hand, not only will the central bank's injection support potentially increase, but with the potential inflow of corporate forex and the effect of comparing deposit and money market fund yields, funds may also flow back to bank deposits more quickly, supplementing bank liabilities and excess reserves.

In terms of forex, with the Federal Reserve clearly starting the rate-cutting process, the US dollar has fallen, easing the pressure of RMB depreciation. In the background of the narrowing interest rate differential between the US dollar and RMB, and the decrease in US dollar opportunity costs, the accumulated trade surplus under the US dollar trend may start to choose to settle in RMB again, especially for enterprises. The fourth quarter is often a peak period for corporate forex settlement, and the increasing demand for forex settlement can indirectly enrich RMB deposits, providing support for RMB liquidity.

Regarding the yield comparison effect, influenced by the faster decline in bond rates compared to deposit rate adjustments, the relative attractiveness of money market funds, wealth management products, etc., has weakened marginally. This has led to a tendency for deposits to flow back, including recent CICC bond market surveys [4] showing that investors' preference for wealth management has declined again, while their preference for deposits has slightly rebounded. We believe that the effect of deposit "relocation" may be coming to an end, which is also conducive to the re-expansion of bank liabilities Secondly, the loose liquidity environment will accelerate the downward adjustment of money market interest rates. Considering that the Federal Reserve will continue to cut interest rates in the fourth quarter, the process of interest rate cuts by the central bank may not be over yet. If internal demand remains weak, there is a possibility that the central bank will further reduce policy rates. There is room for a decrease in money market interest rates.

The reduction in reserve requirements, interest rates, the inflow of RMB due to foreign exchange, and the comparison effect between deposit and money market fund yields all point to the potential acceleration of the downward adjustment of money market interest rates. Moreover, considering that the market generally expects the Federal Reserve to further cut interest rates by 50-75 basis points in the fourth quarter, it means that there is still room for the central bank to follow suit in further interest rate cuts. Especially if internal demand recovery remains slow and corporate confidence fails to improve significantly, the central bank may further increase the intensity of interest rate cuts to stimulate fund activity and provide a good monetary environment for stable price increases.

Therefore, for the fourth quarter, we believe that the main theme of the bond market may still revolve around the money market and short-term interest rates. Money market interest rates are expected to see a significant downward adjustment, opening up space for downward movement in medium and short-term interest rates. Short-term bonds still have a certain safety cushion compared to long-term bonds, and the bullish trend in the bond market may continue.

As for long-term bond rates, the central bank's focus remains, but it is more based on macro prudential risk considerations. The potential tightening of central bank operations and regulatory actions mainly affect the pace of fluctuations in long-term bond rates. The core issue still depends on the strength of fiscal efforts and the swing of risk preferences.

During this press conference, the central bank once again mentioned the operation of long-term bond rates that the market is concerned about. The content of the governor's speech is basically consistent with the previous statements at the Lujiazui meeting, mainly focusing on macro prudential risk prevention. Mentioned topics include "interest rate risk is an important part of financial institutions' risk management," "the central bank provides risk warnings on long-term government bond yields, communicates more with the market, in order to curb the systemic risks that may arise from unilateral downward movements in long-term government bond yields due to herd behavior," "maintaining a good trading order in the bond market is also the responsibility of the central bank," and "strengthening the investigation of illegal activities in the interbank bond market." At the same time, the central bank also clearly stated that "the level of government bond yields is the result of market forces, and the People's Bank of China respects the role of the market." It can be seen that the central bank is not averse to the downward trend in interest rates driven by complete marketization, but is more concerned about the potential risks brought by some illegal trading activities and crowded trades in the bond market.

Therefore, we believe that even if the central bank's potential focus mainly affects the pace of fluctuations in long-term bond rates, it will not change the direction of long-term bond rates. Whether long-term bond rates will rebound from the bottom depends on the change in fiscal policy and risk preferences. We believe that only when fiscal efforts are significantly increased and expenditures shift towards people's livelihoods, reversing the current weak corporate confidence and risk preferences, will we see a reversal of the "asset shortage" situation in the bond market. If fiscal efforts are lacking, the risk of significant outflows of funds from the bond market in the short term remains relatively controllable, and the pressure for a significant increase in long-term bond rates is also limited.

In summary, we believe that the loose monetary conditions and the potential further downward movement of policy rates or the accelerated process of supplementing the downward adjustment of money market interest rates will lead to a significant decline in repurchase agreements, interbank lending, and certificates of deposit in the money market. The downward trend in short-term interest rates in the fourth quarter is still one of the main themes in the bond market, and the steepening of the yield curve may continue

Commodities

Physical demand forming a bottom, further improvement depends on fiscal policy.

The downtrend of commodities in the second half of the year sharply contrasts with the market in the first half. Commodities are facing significant selling pressure, with crude oil representing global demand and iron ore and rebar representing domestic demand falling below $70 per barrel, 90 USD per ton, and 3000 RMB per ton respectively, hitting new lows since 2024.

On one hand, weakening overseas employment and economic data have deepened concerns about a hard landing of the U.S. economy. On the other hand, the slow conversion of Chinese fiscal policy towards physical workloads continues, with lackluster seasonal demand in the traditionally strong September. At the current juncture, the 50 basis point rate cut by the Federal Reserve has been implemented, increasing the likelihood of a soft landing for the U.S. economy and easing concerns about an economic recession. Industrial metal prices, such as copper, have rebounded first. The situation of domestic demand may become the next trading focus in the market.

Currently, domestic commodity demand is bottoming out. From high-frequency data, there are signs of marginal improvement in apparent demand for coal, black metals, and non-ferrous metals, and the pace of inventory clearance has begun to accelerate. Year-on-year electricity generation has seen high growth, thermal power generation has turned positive and expanded to over 10%, coal consumption has maintained strong resilience, terminal inventories continue to decline, and Qinhuangdao coal prices have begun to steadily rebound.

In the black metal sector, there has been some improvement in the month-on-month apparent demand for rebar, with inventories continuing to clear at low levels and steel mill profits also improving. In the non-ferrous sector, copper material production rates are also improving, and although copper inventories are relatively high, clearance is still relatively smooth.

At the current time, with the bottoming out of domestic physical demand, the previous selling pressure on commodities may be somewhat relieved. The introduction of monetary policy may provide a certain boost to market sentiment, and expectations for increased fiscal policy may also rise. We believe that varieties with pricing mainly based on domestic factors may have greater elasticity.

Looking ahead, the key to the sustainability of the rebound in commodity prices still depends on the strength of fiscal efforts and the conversion to physical workloads. From the perspective of terminal demand, construction in investment-side real estate and traditional infrastructure projects remains relatively weak, but since August, the issuance of special bonds has accelerated significantly, and we expect some marginal improvement in the construction side.

In addition, investments with strong countercyclical properties such as new energy power sources and power grids continue to maintain high growth rates. In terms of consumer goods, production of automobiles and household appliances has performed well this year benefiting from external demand. With the policy support of ultra-long-term special national bonds for consumer goods trade-ins, it may further support the performance of durable goods consumption.

Foreign Exchange

We mainly interpret the impact of the central bank's easing policy on the RMB exchange rate. Our conclusion is that the pressure on the RMB exchange rate from the central bank's rate cuts and reserve requirement reductions is relatively limited. In fact, we even see today (September 24th) that the onshore and offshore RMB exchange rates are not rising but instead are rising. How can we explain today's exchange rate performance?

Firstly, although the central bank has cut interest rates, the spread between China and the U.S. is converging. The central bank's interest rate cuts affect the exchange rate through the China-U.S. interest rate spread channel. Logically, a central bank rate cut would widen the China-U.S. interest rate spread, thereby affecting the RMB exchange rate. However, the current changes in the China-U.S. interest rate spread are mainly contributed by the U.S. side. After the unexpected rate cut by the Federal Reserve in September, China-U.S. monetary policies have already converged Even if the central bank cuts interest rates by 20 basis points, this magnitude is still far less than the expected rate cut by the Federal Reserve. Therefore, the central bank's interest rate cut does not change the overall trend of the mid-term narrowing of the China-US interest rate spread, with a relatively small impact on the exchange rate.

Secondly, the interest rate cut on September 24 improved economic expectations and helped attract inflows of cross-border securities investment funds. Exchange rate factors are diverse, with the central bank's interest rate cut affecting the China-US interest rate spread on one hand, and also improving expectations for the Chinese economy. The improvement in economic expectations can drive inflows of cross-border securities investment funds, thereby supporting the Renminbi exchange rate, which will offset some of the negative impact of the interest rate decline.

Furthermore, the supply and demand relationship in the foreign exchange market supports the Renminbi exchange rate. With the Federal Reserve's easing measures and the two-way fluctuations of the Renminbi exchange rate, many foreign trade enterprises have recently increased the proportion of foreign exchange settlement and hedging. This shift in the supply and demand relationship in the foreign exchange market is now favorable to the Renminbi exchange rate. As the year-end foreign trade settlement season approaches, we may see more inflows of settlement funds, which will support the Renminbi exchange rate trend by the end of the year.

Lastly, the central bank's exchange rate policy ensures the stable operation of the exchange rate. Governor Pan mentioned two objectives of the exchange rate policy in the press conference: one is to adhere to a market-determined exchange rate and maintain flexibility, and the other is to strengthen expectation guidance to prevent one-sided expectations from causing exchange rate overshooting. Currently, Renminbi exchange rate expectations have turned stable, and the central bank's exchange rate policy orientation is gradually shifting towards neutrality. If one-sided expectations reappear in the future, the central bank may take action to maintain the basic stability of the exchange rate.

Looking ahead, we believe that there is still a possibility of further appreciation of the Renminbi exchange rate in the short term. This is because further interest rate cuts by the Federal Reserve will lead to a narrowing of the China-US interest rate spread, and because corporate demand for foreign exchange settlement has not been fully met, with a significant amount of USD selling demand remaining before the end of the year.

Therefore, we do not rule out the possibility of the Renminbi exchange rate further appreciating to below 7.0 by the end of the year. In the medium to long term, the changes in the Renminbi exchange rate depend on various factors, including the China-US interest rate spread, as well as cross-border capital flows driven by changes in economic and financial market expectations in both countries. Therefore, in the medium to long term, the Renminbi exchange rate may exhibit a two-way fluctuation trend based on changes in market supply and demand.

Banks

On September 24, the State Council Information Office held a press conference to introduce the relevant financial support for high-quality economic development. We provide the following interpretation of the bank-related policies.

1. Reserve requirement ratio cuts and interest rate cuts to support the economy. Specifically include:

1) Reserve requirement ratio cuts: The meeting mentioned that the central bank will soon cut the reserve requirement ratio by 50 basis points, providing about 1 trillion yuan of long-term liquidity to the financial market; after the cut, the average reserve requirement ratio for banks will be around 6.6%, and the reserve requirement ratio will be further reduced by 0.25-0.5 percentage points at opportune times within the year. We believe that the reserve requirement ratio cut aims to promote bank loan issuance to support economic growth, and the funds released by the cut can earn higher interest income. We estimate that a 50 basis point reserve requirement ratio cut will contribute approximately 1 basis point to banks' interest margins.

2) Interest rate cuts: The meeting mentioned that the central bank will soon cut the 7-day reverse repurchase rate by 20 basis points, leading to a 30 basis point cut in the medium-term lending facility (MLF) rate, and a 20-25 basis point cut in the LPR and deposit rates We believe that the interest rate cut aims to reduce the high real interest rates in the environment of declining asset prices and inflation growth rates. Recently, overseas interest rate cuts and exporters' foreign exchange settlements have also eased exchange rate pressures.

3) Lowering existing mortgage rates: The meeting mentioned that the central bank plans to guide banks to make batch adjustments to existing mortgage rates, lowering them to levels near the rates for new loans. The central bank expects an average decrease of about 50 basis points in existing mortgage rates, affecting 50 million households and 150 million people, reducing households' interest expenses by around 150 billion yuan annually on average. Lowering existing mortgage rates is conducive to promoting consumption, reducing early repayment behaviors, and compressing the space for illegal replacement of existing mortgage loans.

Impact on banks: Assuming a 20 basis point decrease in 1-year and 5-year LPR, an average 50 basis point decrease in existing mortgage rates, we estimate the impact on net interest margins to be 9 basis points and 6 basis points respectively, totaling about 15 basis points. Assuming a 25 basis point decrease in deposit rates and a 50 basis point reserve requirement ratio cut can offset the impact on banks' net interest margins. According to the central bank's calculations, this interest rate adjustment is overall neutral for banks' net interest margins. We believe that the main consideration is to maintain banks' reasonable net interest margins and profits to ensure the stability of the financial system.

2. Financial support for real estate: In addition to lowering existing mortgage rates, real estate financial policies also include:

1) Lowering the down payment ratio for second homes: The central bank has unified the minimum down payment ratios for first homes and second homes, reducing the nationwide minimum down payment ratio for second homes from the current 25% to 15%, with different policies implemented in different regions. We believe that this adjustment is beneficial for increasing the proportion of loans for buyers of second homes for improvement purposes, but whether residents increase leverage is also limited by income (e.g. generally not exceeding 50% of the debt-to-income ratio) and willingness.

2) Extension of financing for real estate developers and extension of policies for operational property loans: The central bank and the China Banking and Insurance Regulatory Commission have extended the maturity of operational property loans expiring by the end of the year and the "16 Financial Measures" policy to the end of 2026. The "16 Financial Measures" include extending the maturity of existing financing for real estate developers by one year and not adjusting loan classifications. We believe this is beneficial for stabilizing the financing cash flow of real estate developers, reducing liquidity pressure, and alleviating the pressure on bank asset quality from exposure to real estate loan risks.

3) Increase in the contribution ratio for re-lending of affordable housing: The central bank has increased the support ratio of the 300 billion yuan affordable housing re-lending program created by the People's Bank of China in May from the original 60% to 100%. The interest rate for affordable housing re-lending is 1.75%, calculated based on the average cost of bank liabilities of 2.2%. With a 100% support ratio, the cost savings for this loan are about 40-50 basis points, which can enhance the incentive for banks to lend. By the first half of the year, nearly 25 billion yuan in rental housing loans had been issued, with the central bank approving over 12 billion yuan in re-lending funds. Progress has been slow, which we believe is also influenced by local government willingness and project returns 4) Support for acquiring existing land. The central bank will study allowing banks to provide loans to support enterprises in the market-oriented acquisition of land from real estate companies, using part of the local government special bonds for land reserve, and when necessary, providing re-lending support by the People's Bank of China. We believe that this loan will also help alleviate the funding pressure on real estate companies. If the acquirer is a state-owned enterprise with a relatively high credit rating, the quality of the related loan assets is also more controllable.

3. Financial support for the stock market. Mainly includes:

1) Non-bank institutions "exchange securities for securities" to increase stock holdings. The central bank will facilitate the exchange of securities, funds, and insurance companies, supporting them to use bonds, stock ETFs, and constituents of the Shanghai and Shenzhen 300 Index held as collateral to exchange for high-liquidity assets such as national bonds and central bank bills from the central bank. The funds obtained through selling or pledging will be used to invest in the stock market, with an initial operation scale of 500 billion yuan. This operation can enhance the ability of relevant institutions to leverage up and increase stock holdings. The specific scale of increase depends on the willingness of non-bank institutions to increase stock holdings and leverage restrictions. The realization method of the exchanged national bonds and central bank bills (selling or pledging repurchase) also needs to be clarified.

2) Loan support for listed companies to repurchase stocks. The central bank will establish a special re-lending facility for stock repurchases and increases, guiding banks to provide loans to listed companies and major shareholders to support stock repurchases and increases. The central bank will provide re-lending to banks, with a support ratio of 100%, a re-lending rate of 1.75%, and a commercial bank loan rate of around 2.25% to customers, with an initial amount of 300 billion yuan.

We believe that the lower loan rate can better incentivize listed companies to borrow funds for stock repurchases and increases. Banks can earn a 50bp interest spread from lending, with the borrowing credit subject being relatively high-quality listed companies. To reduce the credit risk of loans, it is worth paying attention to the credit enhancement methods of this loan in the future, such as whether a certain pledge ratio is set when using stocks as collateral, or other methods such as major shareholder guarantees.

4. Capital injection into large banks. The China Banking and Insurance Regulatory Commission mentioned that the country plans to increase the core Tier 1 capital of six large commercial banks, implementing it in an orderly manner according to the concept of "overall planning, phased implementation, and tailored policies".

In recent years, the loan growth rate of state-owned large banks has been higher than that of small and medium-sized banks, but the decline in interest spreads has also been higher. At the same time, there is pressure to digest non-performing assets through profits and provisions. Against this background, some large banks also face downward pressure on their core Tier 1 capital adequacy ratio. Since core Tier 1 capital can only be supplemented through internal profits or external equity financing, we believe that a new round of capital injection is expected to alleviate capital pressure. Subsequently, the method and structure of financing will be observed, such as whether it will be financed through fiscal or market-oriented means, using targeted issuance, rights issues, or other methods, the relationship between financing price and net asset value per share, the order and pace of financing for each bank, etc.

5. Support for banks' investment in AIC equity. The China Banking and Insurance Regulatory Commission mentioned that they will study: 1) expanding the pilot scope of equity investment in financial asset investment companies (AIC) under large commercial banks from Shanghai to 18 other technology innovation active medium to large cities, including Beijing 2) Relax the restrictions on equity investment amount and proportion appropriately, increase the proportion of on-balance sheet investments from the original 4% to 10%, and increase the proportion of investments in single private equity funds from the original 20% to 30%. 3) Implement the requirements of due diligence exemption, and establish a sound long-term, diversified performance evaluation system. We believe that the above measures are expected to encourage banks to invest in equity through their AIC subsidiaries and enhance their support for technological innovation.

6. Optimize the policy of non-repayment and continuation of loans for small and micro enterprises. In 2014, the original CBRC's policy of "non-repayment and continuation of loans" for small and micro enterprises will be optimized by the subsequent China Banking and Insurance Regulatory Commission:

1. The scope of continuation loans will be expanded from some small and micro enterprises to all small and micro enterprises. Small and micro enterprises with genuine financing needs after the loan expires and facing financial difficulties can apply for continuation loan support. 2) The continuation loan policy will be temporarily expanded to medium-sized enterprises, with a term set at three years. This means that all medium-sized enterprises' working capital loans expiring before September 30, 2027, can follow the continuation loan policy for small and micro enterprises. 3) Adjust the risk classification standards, and renew the loans for enterprises that operate legally, continuously, and have good credit without lowering the risk classification solely due to the renewal. We believe that this policy is expected to reduce the repayment pressure on small and medium-sized enterprises, lower the risk of fund chain rupture, and help stabilize the asset quality of banks.

Bank investment recommendations. We believe that the combination of financial policies reflects a clear signal of stable growth and confidence, and fully considers the impact on bank interest spreads and asset quality while supporting the real economy and capital markets. This helps banks operate steadily while achieving symbiosis and prosperity with the real economy. Capital injection into large banks helps maintain stable credit growth and enhance their ability to resist risks. The dilution level of dividends per share after the capital injection depends on whether the bank's profits can grow faster than the increase in shares. If the bank promotes improvements in the real economy and reduces the credit cost of banks on a stronger capital basis, the dilution effect on dividends per share is limited.

Overall, as we mentioned in "The Logic of Bank Upsurge," there are three medium-term risk points that banks need to pay attention to in the next 6-12 months (liquidity and asset quality of the real economy, existing real estate debt, early repayment by residents), and this round of policies has targeted responses to these risks. For the fundamentals of banks, the key is to observe the substantial effects of a series of policies on the improvement of long-term economic expectations.

Non-bank

The policy combination brings important catalysts, optimistic about non-bank investment opportunities.

The central bank has released a series of policy favorable measures. We believe that multiple policies aimed at providing market liquidity and supporting the development of the stock market will bring strong upward catalysts to the overall non-bank sector. We reiterate our views on insurance and securities as follows:

Insurance: High-quality life insurance is expected to rise with the tide, and there are still significant expectations in the long term. In terms of life insurance, we believe that the overall life insurance sector will benefit from the expected improvement in equity asset yields and further recovery. We reiterate the important investment logic of Chinese life insurance companies: 1) The market has overestimated the risk of spread loss for high-quality companies, and the core profitability of high-quality life insurance is expected to remain stable or increase in a downward interest rate environment; 2) The improvement of the liability side of life insurance is gradually moving from quantity increase to more comprehensive quality improvement; 3) Regulatory policies to prevent risks are expected to protect the industry's reasonable profit levels, which has an undeniable and far-reaching impact on the industry The performance trend of Chinese life insurance companies from the beginning of the year to date has exceeded market expectations, but it basically conforms to our judgment in the annual outlook reports of the past two years. We reiterate that the future profit trend of Chinese life insurance companies is likely to be differentiated, with some companies facing challenges in a low interest rate environment experiencing fluctuating profits or downward trends, while high-quality companies will remain stable or show upward trends. The more challenging the period, the more the financial reports of high-quality companies will continue to confirm their resilience.

Regarding property insurance, we believe that the profit expectations of Chinese property insurance companies will also benefit from the improvement in stock returns. At the same time, the companies' business models have strong resistance to low interest rate environments, with outstanding long-term fundamentals. However, the valuation already reflects this to a large extent, and the future profit potential of companies may lie in the systematic improvement of property insurance valuations when market sentiment remains low.

In terms of overseas insurance, we believe that the interest rate cuts at home and abroad will drive liquidity improvement in the Hong Kong stock market.

In addition, regarding the policy of facilitating exchanges between securities, funds, and insurance companies, we expect that the level of participation of insurance institutions in the short term will mainly depend on the judgment of insurance funds on market direction. However, this policy will still provide additional liquidity for insurance funds when there are investment opportunities in the market.

Securities and Diversified Finance: Seize the current investment opportunities in securities firms and the Hong Kong Stock Exchange. We believe that the performance, valuation, and holdings of the securities sector are currently at a low point. Recent reserve requirement ratio cuts and interest rate cuts provide market liquidity, new policy tools support the development of the stock market (such as facilitating exchanges between securities, funds, and insurance companies/stock repurchase and re-lending), and the acceleration of industry mergers and acquisitions. Focus on the rebound opportunities under the catalysis of merger and acquisition transaction sentiment, market improvement, and internal and external policy catalysts. Focus on two main themes for individual stocks: comprehensive and distinctive securities firms benefiting from domestic and international development under the supply-side reform, and leading internet securities firms with both resilience and growth potential.

1. Listed securities firms' net profit in 1H24 decreased by 22% year-on-year, with a 12% quarter-on-quarter decrease in 2Q, narrowing from the decline in 1Q. Some securities firms benefited from stable performance in asset management/investment and other businesses. We expect that the full-year performance will further narrow the decline on a low year-on-year base, and the inflection point of the sector's performance has emerged.

2. A-share securities firms are currently trading at 1.1x P/B, at the 2.5%/1.6% percentile of the past 5/10 years, while H-share securities firms are trading at 0.4x P/B, at the 4.2%/2.1% percentile of the past 5/10 years. Valuations and institutional holdings are at a low point.

3. The pace of industry mergers and acquisitions has accelerated this year. We are optimistic about the theme of securities firms' mergers and acquisitions driven by regulatory reforms from top to bottom and the internal development needs of securities firms.

In addition, the interest rate cuts provide a foundation for liquidity improvement in the Hong Kong stock market and are expected to drive profit and valuation recovery of the Hong Kong Stock Exchange. The Hong Kong Stock Exchange is currently trading at 26x/24x 24e/25e P/E, still relatively low compared to historical levels. We recommend paying attention to potential economic policies in the future, coupled with overseas liquidity improvements, for the continuous catalyst of the Hong Kong Stock Exchange's valuation recovery.

Real Estate

On the morning of September 24th, the State Council Information Office held a press conference on financial support for high-quality economic development, proposing policies related to the real estate sector:

1. Lower the interest rate on existing housing loans to near the interest rate on new housing loans, with an expected reduction of around 0.5 percentage points. At the same time, a rate cut may also drive down the LPR and new housing loan rates by about 0.2 percentage points. 2) Unified minimum down payment ratios for first and second homes, with the national minimum down payment ratio for second homes reduced from 25% to 15%. 3) RMB 300 billion in re-loans for affordable housing, with the central bank's funding support ratio increased from 60% to 100%. 4) The policy documents originally scheduled to expire at the end of 2024 for operating property loans and the "16 Financial Measures" have been extended to the end of 2026. 5) Research on allowing policy banks and commercial banks to support conditionally enterprise market-oriented acquisitions of real estate developers' land, revitalizing existing land resources, easing the financial pressure on real estate developers, and if necessary, the People's Bank of China may provide policy support.

This policy exceeds market expectations in terms of scope and intensity. In our report "Policy Expectations Boost, Real Estate Sector Still Offers Investment Opportunities" published on August 31, we pointed out that against the backdrop of a still weak industry fundamentals, the possibility of dynamic optimization of real estate policies and counteracting pressures is increasing. It is necessary to pay attention to whether various policies, including the adjustment of existing housing loan rates, may be strengthened simultaneously to form a concerted effort.

The five real estate-related policies proposed in this meeting address the industry's prominent issues of weak demand, credit risks, and inventory bottlenecks with targeted measures:

1. From the demand side, following the nationwide reduction in the down payment ratio for second homes, we expect various regions to gradually adjust their policies under the "differentiated policies for different cities" framework. It is not ruled out that Beijing and Shanghai may also moderately adjust their restrictions on home purchases and loans, which may temporarily alleviate residents' wait-and-see attitude towards home buying. In addition, although the adjustment of existing housing loan rates may not directly stimulate housing demand, it may indirectly improve the economy through consumption pathways, and the downward trend in new housing loan rates guided by interest rate cuts may also provide some support to housing demand.

2. From the credit side, the extension of the effective period for operating property loans and the "16 Financial Measures" policy, which have been effective in alleviating corporate cash flow pressures, for another two years, along with the study to promote policy banks' support for conditional acquisitions of real estate developers' land, suggest that the arrangement and progress of this policy in terms of financing costs, borrowing mechanisms, and implementation scale should be continuously monitored. We expect that the aforementioned policies, together with the project "white list" mechanism, will effectively support the smooth completion of the "building while selling" work and prevent the further spread of credit risks.

3. In response to the slow progress in the acquisition and storage of affordable housing in the past, certain improvements have been made this time. Specifically, the increase in the central bank's funding support ratio to 100% implies that the financing cost of loans will be reduced from around 2.5% to 1.75%. Under the principles of marketization and legalization, the corresponding upper limit of the purchase price will be raised from the previous 50-60% of the market price to 70-80% of the market price, which may accelerate the acquisition and storage work. Continued observation of subsequent progress is necessary (as of the end of June, re-loans amounted to approximately RMB 12 billion).

The sector will enter a period of observing the effects of the policies. Considering that the fundamentals of the real estate industry are still in a trend of contraction in volume and price decline, the comprehensive financial support policies introduced this time may bring about a temporary marginal improvement. However, whether they can lead to a turning point in fundamentals still requires observation of policy effects, as well as whether there will be further efforts to boost economic growth from the fiscal side

Building Materials

On September 24th, the State Council Information Office held a press conference on financial support for high-quality economic development, announcing a reserve requirement ratio cut, a reduction in existing home mortgage rates, and the standardization of the minimum down payment ratio for mortgages, slightly exceeding our and the market's expectations.

From a sentiment perspective, we believe that building materials, as a policy-driven pro-cyclical variety, are expected to benefit from liquidity release. In particular, institutional holdings of building materials are at historically low levels, market sentiment is quite pessimistic, and after overselling, under the catalysis of the reserve requirement ratio cut, they are expected to undergo a phase of valuation repair. Our holding recommendation still focuses on defensive and aggressive balanced allocation-type varieties with ample safety margins. Under the leadership of industry leaders, the cement and fiberglass industry is shifting towards a focus on profits rather than market share. This allows leading companies with cost advantages and safety margins to have certain allocation value in certain positions. Stocks with low positions, attractive dividend yields, and expectations of price increases can be considered as phased allocation of absolute return varieties; consumer building materials and new materials are optimistic about varieties with pricing power and strong cash flow in the context of "small market, big companies".

From a fundamental perspective, the market was previously concerned about the continued sluggishness of real estate sales, and the downward cycle of completions may be further prolonged. We believe that new policies such as reducing existing home mortgage rates and standardizing down payment ratios can boost confidence for enterprises and channels. For varieties in the construction-related sectors such as glass, hardware, coatings, and sand powder, which are more inclined towards completed real estate projects, there is potential to drive demand release for replenishing inventory, thereby marginally alleviating price competition pressure.

Previously, central construction enterprises experienced a certain pullback due to a year-on-year decline in orders and an increase in accounts receivable projects in 2Q24. However, we believe that the acceleration of special bond issuances in 2H24, the higher priority of central enterprises in the repayment sequence, and their superior comprehensive capabilities in order acquisition and repayment far exceed those of local construction enterprises and urban investment platforms. The fundamentals remain relatively robust, and the opportunities brought about by the sector's pullback are relatively more than the risks. Seeking opportunities for low-position allocations, the reserve requirement ratio cut is expected to boost sector sentiment to a certain extent.

Author: Zhang Wenlang, Li Qiusuo, Dong Xu, Wang Zhilu, Li Liuyang, Lin Yingqi, Mao Qingqing, Li Hao, Liu Jiachen, CICC Insight, Original Title: "CICC: Joint Interpretation of Financial Policy Adjustments"