China sneezes, but will world catch cold? Opinion by Bloomberg

Bloomberg has published an opinion piece that says the security blanket that Chinese expansion gave to the global economy for the past two decades is being pulled away. Caliber.Az reprints the article.

It seems like the classic case of be careful with what you wish for. All manner of hopes have been expressed for China’s economy this year. At first, investors were optimistic that a big rebound following interminable Covid-Zero lockdowns would spur global growth.

As it grew clearer that the bounce wouldn’t be that special, their new wish was for enough weakness to force policymakers to inject stimulus. On several occasions over the last two decades, a big release of credit in China has raised boats across the world.

But now, economic woes are proving way deeper than initially feared (or desired). That’s prompted China’s central bank to unexpectedly reduce a key interest rate to spur activity in the face of a worsening property slump, weak consumer spending, and awful macroeconomic numbers. Judging by the initial reaction, even the arrival of stimulus hasn’t cheered everyone up.

As the second-largest economy in the world, the question remains: Can the rest of the globe expand if China is struggling?

This week’s data show that almost all the putative motors of the Chinese economy were growing only at a very disappointing rate. This was true of industrial investment, investment in real estate, investment in fixed assets (such as infrastructure), and retail sales.

The following charts all take a six-month moving average to make them easier to read, given the annual distortions caused by the lunar new year and the extreme pandemic-era swings. As we’re now more than six months past the relaxing of Covid Zero, and as the base effects from a year ago should still flatter growth numbers, it would have been reasonable to expect them to show a strong rise.

China’s dashboard of disappointment

Perhaps worst for confidence outside the country, authorities also announced that they would stop publishing figures on youth unemployment (which hit a record 21.3 per cent in June) while they try to improve data-collection.

 This looks suspiciously convenient and fanned fears about the lack of data transparency. To quote Paul Hickey of Bespoke Investment Group: “Out of sight, out of mind. Right?” (Read more in this QuickTake about why China isn’t providing enough jobs for its young.)

Tuesday’s immediate response saw the People’s Bank of China lower the rate on its one-year loans — or medium-term lending facility — by 15 basis points to 2.5 per cent, the second cut since June and the most since 2020.

This was a surprise, although Bloomberg Opinion’s Daniel Moss argues here that it really shouldn’t have been. All but one of the 15 analysts surveyed by Bloomberg had predicted the rate would stay unchanged.

China Slashes Policy Rates Unexpectedly

But initial reactions suggested that the cut was too little, too late. The news has been bad for a while. We already knew that bank loans had tumbled to a 14-year low in July, with deflation kicking in and exports further contracting. It doesn’t help that the outlook for the real estate market, where Country Garden Holdings Co. — another major property developer that now faces a debt crisis, detailed here by Shuli Ren — continues to look grim.

“The rate cut is necessary just to counter deflation, and will have only a modest impact in boosting demand amid an environment of fragile confidence and low willingness to invest,” said Michael Hirson, head of China strategy at 22V research. “PBOC is very keen to avoid a repeat of the 2015-2016 cycle of currency weakness and capital outflows, so I don’t expect rapid depreciation.

But there are few near-term catalysts to support a sustained strengthening of the currency without greater efforts to boost growth.”

A critical unknown is the response of President Xi Jinping. He so far has resisted plans for new stimulus to help out the property sector and give consumers more cash to spend — two of the areas that Cai Fang, a central bank adviser, has referred to as the “most urgent goal.”

Indeed, Xi’s administration, anxious to avoid any Chinese rerun of the US subprime loan debacle, took the aggressive decision to clamp down on real estate speculation two years ago. Had they known that Covid-19 would return to hit China hard in 2022, they might not have made that move.

To Kristina Hooper, chief global market strategist at Invesco, there may be a silver lining.

“I expect this situation to accelerate the rollout of property support — and perhaps even prompt greater policy support than had originally been planned,” she said. “That in turn could be a positive catalyst for Chinese stocks, which have been under pressure this year.”

The most dramatic financial effect to date has been on the currency, with the yuan now almost as weak as at its nadir immediately before the Covid-Zero restrictions were lifted. It is close to a 14-year low, and far cheaper than in the summer of 2015, when a badly communicated devaluation prompted a minor global crisis.

China's Currency: No Longer Strong

The shift in the balance between the world’s two leading economies is clearest when looking at bond yields. For many years, China’s 10-year bonds have consistently yielded more than Treasuries, which makes eminent sense when China’s economy has been growing so much faster.

US-China yield gap wildest since 2007

The yield gap between 10-year US and Chinese government bonds is now more than 160 basis points, the widest since 2007. In a longer-term perspective, this is very healthy. It means that more than a decade of US dependence on holding rates low while relying on China to drive growth are over.

But in the shorter term, a spread like this can be expected to fuel further outflows, and increase the pressure on Chinese authorities to make some kind of currency intervention:

Beyond China’s Shores

If China’s economy is really in trouble, what does it mean for everyone else? The alarm from officials in the west is growing deafening. US Treasury Secretary Janet Yellen said the slowdown was a “risk factor” for the American economy, while President Joe Biden evoked a “ticking time bomb.”

News coverage has been full of references to Japanification — the notion that China, like Japan more than three decades ago, could slide from strong growth and an overheated property market into years of deflationary slump.

In direct terms, Capital Economics offers this handy chart that ranks economies by how much of their gross domestic product comes from commodity exports to China. It implies terrible news for Zambia, whose mineral exports are a huge chunk of GDP, and also problems for the big metal producers of South America and Middle Eastern oil exporters:

Bloomberg Economics suggests that fears are overstated, and that a cushioned decline in China’s growth would have only a “limited impact on the US economy.” In a downside scenario where China under-delivers on stimulus and growth spirals down, the Fed could be tipped into rate cuts sooner than expected. And while drawing the comparison with Japanification is tellingly negative, many suggest that the risk is overdone.

I recommend this podcast, in which Columbia academic Adam Tooze points out that for all the obvious similarities, Japan had arrived as the world’s richest country before it slid into slump. China is still a middle-income country.

Even so, the medium-term outlook could ostensibly be seriously bearish for investors. Markets have already had to get used to the end of the “put” from the Fed as the lender of last resort. If they also have to survive without the Chinese “put” as the buyer of last resort, a lot of cosy assumptions from the last two decades come into doubt. Win Thin, global head of currency strategy at Brown Brothers Harriman, suggested that China could muddle through in the short term. But:

Longer-term? Not so much. With debt/GDP approaching 300 per cent, there are limits to returning to the old debt-fueled stimulus. Furthermore, China can no longer grow their way out of their problems as it struggles to meet its target for this year "around 5 per cent." Besides the obvious downside risks to global growth, we don’t yet have a firm grasp of the potential global financial impact from a debt event in China but that is clearly the big “known unknown.” As always, the big ‘unknown unknowns’ elude us until it’s too late.

That is very much the philosophy that animated Western markets’ attitude toward China for years after the Global Financial Crisis. But it’s not the general thinking at present. Risk assets had a bad day Tuesday, showing the rate cut had failed to impress, though it could have been far worse.

The S&P 500 fell 1.2 per cent, but it’s still up more than 15 per cent for the year. The monthly Bank of America Corp. survey of global fund managers was published Tuesday, and charts of the evolution of what respondents label the “biggest tail risk.” From 2013 to 2016, the Chinese economy and the danger it would crash headed the list, while trade war with the US dominated attention for the years before the pandemic. Now, however, fund managers are still much more worried about global inflation.

A Chinese hard landing didn’t even make the top five perceived risks. That’s strange, given that such a scenario looks a much more imminent threat now than a decade ago, when China seemed to be the sum of all fears.

That might be because financial markets are a little less exposed to China these days, at least directly. When the country was preoccupying the rest of the financial universe, its stock market had still handily outperformed. The de-rating of the last few years has been spectacular, and China’s stocks now lag the rest of the world since 2000, despite its vastly superior growth:

Maybe it’s in the price

This might help explain why investors feel they’ve adequately priced in the new reality, and so it doesn’t create as great a tail risk as before. But there is, of course, much more to Chinese exposure than its stock market. As Beijing’s leadership remains autocratic and reactive, and is facing a challenge to its credibility, the risk that something big is in the offing looks underpriced.

Finger on the (MLIV) pulse

Now a brief public service announcement. We’d like your participation in a survey, especially if you have strong views about the higher-for-longer interest rates and the path of inflation. Points of Return readers tend to care about these things, and you can share them in the latest MLIV Pulse survey, produced by our friends on the Markets Live blog, which focuses on the Jackson Hole central banks symposium next week.

The key question is: “Will High Interest Rates Be the New Normal?” For the record, my answer would be that higher rates than we’ve been accustomed to in this century will almost certainly be the new normal, but there’s still no reason for them to be particularly high by the standards of the 1970s and 1980s. That can be avoided. You can find the survey here.

Survival Tips

Some more visual arts from Mexico. At Mexico City’s Jumex Museum (even fruit juice brands have their own art museums), I was lucky to see a big exhibition by Gabriel Kuri.

It was a great collection of works examining finance and its role in our lives. In particular, and this astonished me, Kuri was fascinated by behavioural finance and wanted to explore how our minds perceive financial products and services.