What Does a Third Rate Cut Mean?

04/08/2015 12:01 am EST

Focus: GLOBAL

Jim Jubak

Founder and Editor, JubakPicks.com

The PBC's announcement over dropping inflation helped push the Shanghai Composite to a multi-year high and MoneyShow's Jim Jubak explores the impact of another rate cut.

On Monday, March 30, the Shanghai stock market raced ahead by about 2.6% and set a new seven year high. The impetus there was remarks over the weekend from the governor the People's Bank down at Central Bank basically saying, “Hey, deflation was a worry, inflation was falling more quickly than anyone expected,” and that led traders in Shanghai to say, “Hey, the Central Bank is going to cut interest rates again.”

The People's Bank has cut interest rates twice since November, I think a third cut is indeed likely and growth is indeed slowing.

Inflation in January was an annual—that's year over year—0.8%, that's down from an already low 1.5% in December.

This is a five year low for inflation and then we're getting down to the point where the Central Bank is worried about deflation, which means that they're likely to cut interest rates to try to speed up the economy.

People are now talking about growth in China being below 7%; 6.8% and 6.4% are numbers that we're starting to see kicked around. All this means that, I think, we're starting to get to the point where the government in Beijing and the people of the Central Bank do indeed worry and that is likely to mean another cut in interest rates.

How much of that is already baked into the Shanghai prices is a good question. I think a lot of is, but my expectation is that after some profit taking here, we'll see a rebound in stocks and move to a new seven year high in Shanghai.

A lot of that is because I think that the last two interest rate cuts weren't terribly effective. The expectation is this one won't be either and if that looks like it's the case then the expectations for a fourth interest rate cut will pretty much immediately go into effect. I wouldn't necessarily chase the Shanghai market here. We are at a seven year high.

This is a very volatile traders market and we're starting to get some really negative news from China's big banks where we're seeing very large increases in bad loans.

Those are likely to worry traders again because those are big stocks, so I wouldn't chase Shanghai here. I don't think necessarily you need to move out of it because I think the market is in short-term headed up, but we're starting to get to a top and in China it's always dangerous at the top.

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