If the last two weeks are any indication, “winning” a trade war with China is going to be anything but “easy”, as Donald Trump famously claimed earlier this year.
The sheer number of tools at the PBoC’s disposal when it comes to easing domestic liquidity conditions and the Politburo’s willingness to implement fiscal stimulus in order to juice domestic demand together mean China is well equipped for a lengthy war of attrition.
On Monday, the PBoC offered up 502 billion yuan in one-year MLF, the largest deployment of that policy tool on record. That came on the heels of a 189 billion yuan operation conducted earlier this month and designed to help cover maturities. That was just the latest in a string of moves aimed at perpetuating the easing bias that’s helping to widen the policy divergence with the Fed.
This push has been perceptible for months, but began in earnest when the PBoC eschewed raising OMO rates following the Fed’s June hike, on the way to delivering a highly anticipated RRR ten days later.
Credit data for June would confirm that the deleveraging push is indeed beginning to bite as M2 grew just 8% YoY last month, the slowest pace in more than two decades. Non-bank and off-balance-sheet lending actually contracted 0.6% YoY. As Credit Suisse wrote, that’s “the first [contraction] in recent history.”
That underscored the need to put the brakes on the deleveraging effort in order to avoid choking off credit growth to the real economy.
Last Wednesday, reports suggested the PBoC is all set to incentivize commercial banks to increase lending and investment in corporate bonds. That’s yet another example of the central bank pulling levers to perpetuate the easing bias and has it turned out, more proclamations were forthcoming. Here’s Goldman:
The goal of maintaining TSF growth was the driver of Friday’s coordinated release of documents by the PBOC, CBRIC and CSRC. June data showed the rapid contraction of shadow banking activities needs to be changed if TSF is to maintain stable growth. The issuance of the documents and the visit by Chairman Guo to BOC seemed to give financial institutions and the markets an indication of the government’s intention, including the bank regulator.
All the while, the PBoC has countenanced the yuan weakness that’s part and parcel of the policy divergence between Yi Gang and Jerome Powell. In short, the yuan has a green light to weaken, up to and until there’s evidence of capital flight. On Tuesday, the currency fell to its weakest against the dollar in a year.
That, in turn, is blunting the impact of the tariffs.
“The nearly 10% USD/CNY move since March has almost completely offset the impact of Trump’s potential tariffs before they have even happened”, Deutsche Bank wrote over the weekend, adding that “perhaps this is why the US President’s Twitter feed has turned back to talking down the dollar.”
All of this has generally been accompanied by weakness in Chinese equities, which fell into a bear market this year. The U.S./China equity ratio is sitting at its lowest levels in over a decade.
On Tuesday, Chinese equities rallied – hard. The reason for the ebullience: more stimulus measures announced following a meeting of the State Council in Beijing.
Fiscal policy, the State Council says, will now be “more proactive.”
Officials said there “should be no broad stimulus with flooding liquidity” but rather the intent is to “adjust macro policy according to the situation with targeted measures”, a clear sign that the PBoC isn’t alone when it comes to fighting this battle.
“From a tax cut aimed at fostering research spending to special bonds for infrastructure investment, the measures announced late Monday following a meeting of the State Council in Beijing are intended to form a more flexible response to ‘external uncertainties’ than had been implied by budget tightening already in place for this year”, Bloomberg writes, recounting.
More important, perhaps, than the actual measures is the language. “The most significant [part of this] is the change of the fiscal policy tone”, Goldman wrote on Tuesday, adding that “these measures should ease market concerns over the economy.” You should “expect more” such policy initiatives the weeks ahead, the bank figures.
Credit Suisse agrees. “The shift in tone and intent, likely to be confirmed by the Politburo economic work meeting that may take place in the last week of July, is more important than the details per se”, the bank writes, before noting that “the government seems concerned that growth has slowed too much and that the economy faces some risk from US-China trade tension.”
You can read the full statement from the State Council below, but suffice to say this is just the latest example of China gradually moving towards a coordinated easing effort across agencies and employing a diverse set of tools and policy levers in an effort to ensure the trade frictions don’t lead to a sharp deceleration in economic activity.
Stocks loved it. The Shanghai Composite has risen 1% or more for three consecutive sessions and is now sitting at a its highest levels since June 20.
Here’s what CMB International Securities analyst Daniel So told Bloomberg with regard to the fiscal measures:
The State Council meeting sends a positive signal to the market. Investors are expecting fiscal and monetary policies will be loosened a bit in the second half. Funding for infrastructure projects is expected to be guaranteed so construction-related sectors such as cement makers are surging today.
Again, this isn’t going to be an “easy” win for the United States, no matter how many times Donald Trump suggests otherwise. China is playing the long game here, while Trump is seemingly worried about political expediency.
“We note that policymakers have been loosening policy gradually since April and only when the loosening is seen as insufficient do they take additional measures”, Goldman wrote, in the same note cited above. “We expect this to remain the strategy going forward.”
Full statement from the State Council
On July 23, Premier Li Keqiang presided over the State Council executive meeting to deploy and play a better role in fiscal and financial policies, support the expansion of domestic demand structure to promote the development of the real economy, and determine measures to promote effective investment around short-boarding, increasing stamina and benefiting people’s livelihood.
The meeting listened to the report of financial and financial support for the development of the real economy, demanding that the macroeconomic policy be stable, insisting on not engaging in the “great flooding” type of strong stimulus, adjusting the camera’s pre-adjustment and fine-tuning according to the situation, and coping with the uncertainty of the external environment. Keep the economy running in a reasonable range. Fiscal and financial policies should work together to serve the real economy more effectively and serve the macroeconomic situation more effectively. First, the active fiscal policy should be more active. Focusing on tax reduction and fee reduction, on the basis of ensuring that the burden of taxation and fees of the market is reduced by more than 1.1 trillion yuan for the whole year, the policy of increasing the deduction rate of R&D expenses to 75% will be expanded by technology-based SMEs to all enterprises. It is estimated that the annual tax reduction will be 65 billion yuan. The 113 billion yuan that has been refunded for the value-added tax refunds for advanced manufacturing and modern service industries will be basically completed by the end of September. Strengthen the convergence of related parties, accelerate the issuance and use of special bonds of local governments of 1.35 trillion yuan this year, and achieve early results in promoting infrastructure projects under construction. Second, a sound monetary policy should be tight and moderate. Maintain a moderate amount of social financing and ample liquidity, unblock the transmission mechanism of monetary and credit policies, and implement the various measures that have been introduced. Through the implementation of account management, etc., the establishment of a responsibility system, the implementation of small loans, small and micro enterprises and individual industrial and commercial household loan interest exemption from value-added tax and other policies have been put in place. Guide financial institutions to use the RRR cuts to support small and micro enterprises, market-oriented debt-to-equity swaps, etc. Commercial banks are encouraged to issue small and micro enterprise financial bonds, exempting issuers from continuous profit requirements. The third is to speed up the funding of the National Financing Guarantee Fund and strive to achieve the goal of newly supporting 150,000 (micro) small and micro enterprises and 140 billion yuan in loans each year. The awards will be awarded to the places where the scale of financing guarantees for small and micro enterprises will be expanded and the costs will be reduced. The fourth is to resolutely clear out “zombie enterprises” and reduce the use of invalid funds. Continue to crack down on illegal financial institutions and activities, and keep the bottom line of systemic risks.
The meeting held that inspiring social vitality and promoting stable investment in effective investment are important measures to promote supply-side structural reforms to fill shortcomings, consolidate economic stability, and promote employment. First, we must deepen the reform of the “distribution service” in the investment field and mobilize the enthusiasm of private investment. In the fields of transportation, oil and gas, telecommunications, etc., we will introduce a number of projects with private investment as the mainstay, clear investment return mechanism and great commercial potential. We will promote a high level of opening up to the outside world, improve foreign investment reinvestment incentive policies, and accelerate the landing of contracted foreign investment projects. Second, we must effectively protect the funding needs of projects under construction. Supervise and urge local governments to revitalize fiscal stock funds, and guide financial institutions to ensure the financing needs of financing platform companies in accordance with the principle of marketization, and to avoid capital outages and unfinished projects for necessary projects under construction. Third, we must meet the needs of development and people’s livelihood, and promote the construction and reserve of a number of major projects. Strengthen basic research and core technology research in key areas. The meeting adopted the petrochemical industry planning and layout plan, requiring safety and environmental protection priority, and supporting private and foreign-funded enterprises to sole investment or holding investment to promote industrial upgrading.