Further Tightening From China

On the heels of their unconventional efforts to slowdown the growth of bank loans, the Chinese monetary authorities announced today a more traditional measure to tamp down its incipient real estate bubble.

Specifically, China announced today a 50 basis point increase in the reserve-requirement ratio for banks, with effect from February 25. This will constrain banks to keep 16.5% of their deposits with the central bank on reserve, up from 16% before.

This came about a month after a boost to the reserve-requirement ratio, which is expected to remain a key monetary lever for the Chinese authorities. The surprise aspect of the announcement was due to its coming a day ahead of the Chinese New Year celebrations, for which the local markets will be closed next week.

It is far from certain that they will succeed in a venture where many experienced central banks elsewhere have come short. But China has been defying conventional wisdom for awhile now.

In sustaining a breakneck economic expansion over the last two decades that has moved tens of millions of poor Chinese into the ranks of a growing middle class, the Chinese authorities have charted their own course. In the process, they have made their country the third (or almost second) largest economy in the world behind the U.S. and Japan and a major driver of global growth.

China’s centrality to the global economy makes today’s announcement on bank reserves that much more important to the markets. This is particularly so given recent market jitters about Greece-related soverign risk issues, which only receded to the background after eliciting a response from the EU authorities. The U.S.  Fed has also been choreographing its exit strategy by terminating its mortgage purchases in the coming weeks and incentivizing banks to keep excess reserves at the central bank through higher interest rates.

All this, with a backdrop of continued doubts about the sustainability of the U.S. recovery, has kept stocks range-bound despite solid fourth-quarter 2009 results. I don’t think today’s announcement from China will be helpful to the markets, either.

Particularly exposed will be commodities and basic materials, though any company with a China exposure (effectively everyone) will be under pressure. Look for oil, copper, coal and the other commodities to give back recent gains. As a result, oil-levered names like Transocean (RIG: 83.38 -2.60 -3.02%) and Chevron (CVX: 71.01 -0.04 -0.06%) and copper producer, Freeport-McMoRan (FCX: 73.68 -0.49 -0.66%) may be under pressure. I would expect to see weakness in emerging-markets-related equities as well.