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China cut its benchmark lending rate and deposit rate by 25 basis points Thursday morning. This was the first cut since 2008 as they are worried about being able to sustain adequate growth.
China's target is for gross domestic product growth of 7.5% this year. GDP came in at 8.1% in the first quarter. China has also suspended the implementation of new banking rules until 2013 to allow banks the flexibility to achieve reasonable credit growth.
One could almost say that China blinked in the face of the Federal Reserve. The Fed's Beige Book report Wednesday put the best possible face on the state of the U.S. economy.
Stocks are continuing the short-covering rally that began on Monday. The euro ( ) has surged back over $1.26 on the hopes that China's rate cut will spur global growth.
In short, the world bond and currency markets have been moving away from the lows of last Friday after the dismal U.S. jobs report. The rate cut by China can also be seen as supportive for the Shanghai Composite ( ), which closed below 2300 Thursday (before China lowered rates.) That's off nearly 7% from a year-to-date high of 2452.
In response, Japan's yen has extended its losses versus the dollar, euro and China's yuan as markets open up into a more risk-on posture. The steepening yield curve in Japan is corroborative evidence of this as well. The fact that the yen is moving down against the yuan in the face of a Chinese rate cut shows just how big the fear trade was last week.
The Nikkei () has risen 407 points from Monday's open, while the yen has sold off 2.2%; making further easing actions by the Bank of Japan more remote.
Japan will be quite happy for the yen to trade in its current band between 76 and 80 versus the dollar; giving Japan the opportunity to export some of their inflation through overseas investment and the building of yen reserves by regional central banks -- including China's.
Markets had become so distorted by fear that the dollar is even dropping. The extreme demand for greenbacks has sent long-term Treasury bonds yields back up slightly. The iShares Barclays 20+ Yr Treasury Bond ETF () has dropped 4.2% in three days.
None of these moves, however, have been big enough to be considered a trend changer yet. But they have the potential to be so.
For anyone that played against the fear trade on Friday, they have been handsomely rewarded for their fortitude. While all eyes are on Bernanke, watch what the markets do rather than what he says.
The Fed's real policy will be found in the bond and gold markets. If this correction in bonds and gold continues, it will reveal that investors think the Fed will remain accommodative - regardless of what Bernanke says.
China has done its part after the ECB left interest rates unchanged ... essentially deferring to the Fed.
China's rate cut -- without a commensurate drop in the reserve requirement ratio -- is a token move by the People's Bank of China to calm the markets down. But it will not change the fundamentals of the European banking system.
The Fed's next policy decision is due out on June 20th and that is the major event the markets are looking forward to.
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