Call me naive, but I’m still not 100% convinced there’s a “limit” to how much China can do when it comes to pulling various fiscal and monetary policy levers to juice the economy.
Do note that there’s a difference between saying Beijing’s bag of tricks is basically bottomless and saying those tricks will work when it comes “reflating” – as it were. As Goldman wrote last week, the credit transmission channel in China clearly needs some “unclogging.”
“Throughout 2018, China’s policymakers adopted a supportive monetary policy stance, as evidenced by the reduction in the 7-day repo rate since the early part of last year and the series of reductions in the banking sector required reserve ratio, among other policy measures”, the bank wrote, in a January 16 note, adding that “although the supportive stance aimed to mitigate downward pressure on activity levels, Chinese growth continues to slow, suggesting that the transmission channel for monetary policy has become less effective.” One way to visualize that is the disconnect between market rates and bank lending rates, with the latter refusing to fall in line with the historical relationship between the two.
I’ve read a ton of research over the past couple of months that suggests Chinese fiscal policy is more “constrained” than many market participants believe. To be sure, all manner of overt references to a “proactive” fiscal stance and near daily nods to tax cuts and other measures aimed at bolstering the economy have thus far been largely ineffective at putting the brakes on the deceleration in the activity data.
But again, all of the above relates not so much to actual limits on what Beijing can try, but rather to whether anything they try will ultimately work. Those are two different things. At a conceptual level, the whole “it needs to get worse before it can get better” theory vis-à-vis the incoming data assumes, almost by definition, that eventually Beijing will “kitchen sink it” (so to speak) and that when they finally do go “all-in”, it will be some semblance of effective.
Well, we’ll get a real test of whether the whole “it needs to get worse before it can get better” narrative is really something folks are willing to buy into (figuratively and literally) this week when China unveils a raft of critical data.
Here’s Reuters with the Cliffs Notes version:
Analysts polled by Reuters expect the world’s second-largest economy to have grown 6.4 percent in the October-December quarter from a year earlier, slowing from the previous quarter’s 6.5 percent pace and matching levels last seen in early 2009 during the global financial crisis.
That could pull 2018 GDP growth to 6.6 percent, the lowest since 1990 and down from a revised 6.8 percent in 2017.
The data – assuming it is indeed lackluster – will add to a growing body of evidence to support the contention that more stimulus is necessary. Recent disappointments include both the official and Caixin manufacturing PMIs falling into contraction territory, retail sales growth diving to the lowest since 2003 and December trade data missing estimates by a mile as the front-loading effect (predictably) disappeared.
Here’s Barclays rehashing the familiar story in the context of the most recent trade headlines:
Just as the US-China trade story is showing progress, there are signs that China’s economy is slowing further. Credit growth has been weak, December PMIs fell into contraction territory, and 2018 saw car sales decline for the first time since the 1990s. We expect growth and activity data (Monday) to bolster the view of a slowdown. In addition, despite optimism on US-China trade ties, higher tariffs remain in effect and China’s exports in December declined more than 4% y/y. Later this month, China’s Vice Premier Liu He will visit Washington (30-31 January) to speak with US Trade Representative Lighthizer and Treasury Secretary Mnuchin. Even if a deal if reached, we do not expect the US to remove the existing tariffs and offer a quick boost to China’s growth. We see downside risks to our growth forecast of 6.2% this year.
December’s credit data suggested that easing measures might be starting to “work”, but as noted above, the transmission channel isn’t functioning efficiently, which means everyone will be watching closely over the next several months to see if the latest RRR cut manages to loosen things up.
Meanwhile, recent yuan strength (and, relatedly, the Fed’s dovish pivot) is both a blessing and a curse. On one hand, the fact that the Fed is clearly predisposed to taking an extended pause means the Sino-US monetary policy divergence isn’t being pressured wider on both sides anymore. That, in turn, gives China more room to ease (as any easing from Beijing isn’t being effectively amplified by a tightening bias on the US side). On the other hand, the drop in the dollar occasioned by the Fed pivot led directly to a blockbuster week for the yuan earlier this month and that’s a bit troublesome at a time when export growth is slowing.
“As trade tariffs remain in place and the domestic economy slows, the recovery of the CNY to below 6.80 is unlikely to be celebrated by the authorities”, Barclays writes, in the same note cited above, adding that “this may explain why the PBoC fixed USDCNY in line or higher than expected for the six days until 17 January – the longest such streak in which the counter-cyclical adjustment factor was not used to steer the currency stronger.” In other words: the PBoC isn’t entirely comfortable with a rapidly appreciating yuan.
As noted last week, markets zoomed in on record liquidity injections ahead of the holiday. Here’s the chart on that again for anyone who missed it:
Although that appears designed to do more than just meet seasonal demand, Barclays warns against reading too much into it. “The injection has yet to push the 7d market repo fixing rate below 2.55% and we think the PBoC is probably only ensuring that liquidity does not tighten in the run-up to Chinese New Year in early February”, the bank notes.
In any event, it’ll be interesting to see how everyone reacts to this week’s marquee data. This will be a good barometer of whether bad news is indeed “good” news when it comes to China (i.e., “things have to get worse before they can get better”) or whether bad news is just bad news (i.e., the engine of global growth and trade is buckling under the weight of the trade war and stimulus is unlikely to work). For what it’s worth, the China economic Policy Uncertainty Index has exploded higher, but riskies are generally neutral.
Finally, here’s a snapshot of the “problem”, using Bloomberg’s China credit impulse index.