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China rides in to save the (stock market’s) day

by City Index

The night is darkest just before the dawn, and the recent price action in global markets certainly qualifies as pitch black. On what’s been called “Black Monday” equities sold off across the board, with the widely-watched Dow Jones Industrial Average (DJIA) of 30 massive US companies falling by over 1,000 points early in the morning. While stocks did bounce slightly from there, the DJIA still closed the day down nearly 600 points, garnering top story treatment on the evening news across the US.

As the selloff spilled over into Asian session trade, the People’s Bank of China (PBOC) finally decided that it had seen enough, and stepped in to try to stem the decline. The central bank cut interest rates for the fifth time since November, lowering the 1-year lending and deposit rates by 25bps to just 4.6% and 1.75% respectively. In addition, the PBOC reduced the reserve requirement ratio (RRR), or the portion of deposits that Chinese banks must hold as a backstop against losses, by 0.5% to 18% for large banks. At the margin, this change is meant to stimulate the economy by encourage citizens to borrow and banks to lend more money, though the absolute impact on China’s economy, much less the world economy as a whole, may be limited and delayed.

It’s worth noting that all the previous interest rate cuts by the PBOC have taken place over the weekend, when businesses and market participants would have time to digest the move before the start of a new week. Today’s midweek action signals that policymakers are concerned with the recent volatility, but still willing to step in and provide support for the market. Though the economic impact of this move may be limited, the psychological result is reassuring for jittery traders.

Market Impact

As of writing, the PBOC’s bold action appears to have stabilized sentiment in global markets. European and US equities are trading higher by around 4%, erasing the majority of the losses from “Black Monday.” That said, Monday’s big selloff did plenty of technical and psychological damage, so a return to the halcyon days of global bull market in stocks appears unlikely.

In terms of the DJIA, the key level to watch will be 17,000. That level represented previous support for the US index back in December 2014 and February 2015; now that it has been broken, it may present a key level of resistance, or possible ceiling, on prices. Only if US stocks can break back above that key level will a recovery back up toward the all-time highs above 18,000 become a legitimate possibility again.

In other words, only time will tell if today’s PBOC-induced recovery will mark a significant bottom in the market or whether it’s merely a “false dawn.”

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