In my opinion, optimism about China and US employment were larger factors in the US risk rally today than the slight beat on the ISM manufacturing survey.

The risk, for me, is that the market has priced in a cut in China’s reserve ratio before Chinese new year (Jan. 23). That cut may be in jeopardy.

The expectations are largely built on an editorial from the China Securities Journal in mid-Dec saying the cut was “likely”.

Since then, improvements in the US and rising commodity prices might have officials thinking twice. On the weekend, the official Chinese PMI was at 50.3 vs 49.1 exp. The prices sub-index also rose to 47.1 from 44.4.

If those cuts aren’t coming, expect a signal in the week ahead, well before the new year’s holidays. The reaction would be a drop in risk assets, with AUD lagging.

  • From the beginning of 2010 to June, the reserve ratio was hiked by 600 bps.
  • The PBOC cut the reserve ratio on Nov 30 to 21.0% from 21.5%; it was the first cut in three years.
  • For 2012, 200 bps of cuts are priced in.