Last week brought another glimmer of hope for China bulls clinging to the notion that December’s activity data, while dour, betrayed signs of “stabilization” for an economy beset on all sides.
Specifically, China’s official manufacturing PMI (which, while printing in contraction territory again, ticked higher to 49.5 for January) was the latest bit of incremental evidence to suggest “things are stabilizing at a low level” – that story is basically the glass half-full take at a time when the Chinese economy is growing at the slowest annual pace in more than a quarter century.
Unfortunately, the Caixin gauge – out Friday – told a different story. It printed 48.3 in January, down from 49.7 in December. That was well below estimates and is the lowest reading since February 2016. Here’s where things stand:
There were some signs in the December credit data that stimulus is starting to work its way through to the real economy. The headlines were seemingly upbeat, as TSF, new yuan loans and M2 growth all came in solid at CNY1.59 trillion (est. 1.3 trillion), CNY1.1 trillion (est. 825 billion), and +8.1% (versus 8% in November), respectively.
That said, it is still abundantly clear that the credit transmission channel in China needs some “unclogging.” It remains to be seen whether the most recent RRR cut (and other measures, including the rollout of TMLF) will be effective when it comes to getting credit flowing and in the meantime, Beijing has of course tipped/implemented all manner of incremental fiscal measures designed to bolster the economy.
All the while, trade tensions persist and despite the incessant drip of upbeat headlines, it is by no means clear there’s been meaningful progress on the structural issues at the heart of the Sino-US dispute.
That’s the context for a notable call from Barclays’ Jian Chang, who expects the PBoC to cut the benchmark rate sooner rather than later.
“While RRR cuts have lowered banks’ funding costs and targeted easing measures have supported credit growth, average loan rates have remained elevated despite falling interbank rates and bond yields”, she wrote Friday, adding that “with credit risk premiums likely staying elevated, we believe lowering the risk-free rate is an unavoidable option.”
Here’s a Cliffs Notes version of the point-by-point rationale for why a benchmark cut is needed on top of recent efforts:
Amid significant downward pressure on growth, the PBoC rolled out many easing measures, including RRR cuts and the creation of new policy tools such as CBS, TMLF and CRM, aiming to address three main tasks: 1) lowering financing costs in the real economy; 2) enhancing monetary policy transmission from liquidity easing to credit extension; and 3) supporting the private and SME financing. While such targeted measures are useful tools serving the specific above purposes, they have proved insufficient to arrest the downward pressures or reduce financing costs. Hence, we forecast the PBoC to cut benchmark lending rates twice by 25bp each in Q1 and Q2, possibly as early as around 1 February.
Again, this is notable. China has obviously steered clear of benchmark cuts in favor of myriad other monetary easing levers, so this would be a critical inflection point. Here’s a handy table from Barclays that lists all of the PBoC’s monetary and credit tools:
When it comes to the transmission channel being “clogged” (as mentioned above and as discussed in these pages on too many occasions to count), Barclays lists numerous examples. “[The] lack of monetary policy transmission… is reflected in the fact that: 1) the significant liquidity easing has not translated into a sustainable recovery in credit creation, 2) the falling interbank rates have not translated into a lower average bank lending rate; and financing costs of the real economy have remained elevated”, the bank writes, before reiterating that while December’s credit data did show some signs of stabilization (see second chart above), “it is fair to say that the easing has yet to be transmitted to a meaningful reduction in the financing costs of the real economy.”
To support that contention, the bank cites their own “effective lending rate” which they derive by “extending from the PBoC’s quarterly weighted average lending rate to incorporate bond yield (1yr AAA) and trust loan rate (1yr).”
Rising loan rates are no good in an environment where the role of loan financing is growing amid Beijing’s efforts to squeeze leverage out of the labyrinthine shadow bank complex (see right pane above).
One key point in all of this is that the PBoC is pushing on a string to a certain extent. As the economy decelerates and banks are loath to take risk, it’s commensurately difficult to unclog the transmission channel, especially as defaults rise/are tolerated. That, in turn, means the central bank will be compelled to go ahead with a benchmark cut – or at least according to Barclays. To wit, from the note:
Given such a trend is expected to continue in the near term – ie, credit creation slowly recovers while transmission from money market rates to loan rates remains constrained, we think a more direct and quicker way to lower financing costs (to stimulate demand) would be a benchmark lending rate cut. In addition, with credit risk premium likely staying elevated in a downcycle, we think cutting the risk-free rate is becoming more necessary and imminent.
Barclays also cites the prevailing economic backdrop and how it lines up with past easing cycles which were carried out amid contraction-territory manufacturing PMI prints, marked slowdowns in export growth, rapid declines in PPI inflation, contracting industrial profits, serious slowdowns in retail (and auto) sales and a plunging domestic equity market. All of those conditions are met today (at least to some extent).
This is one case where the source of the call matters. Jian Chang was literally the only economist to predict cuts in 2014. Here’s a trip down memory lane via a November 2014 Bloomberg article:
Chang was the sole economist in September, October and November surveys by Bloomberg News to predict a rate cut this quarter. While feeling a bit “conflicted” after a September speech by Premier Li Keqiang signaled a preference for targeted stimulus measures over broad-based easing, Chang remained of the view that a move on benchmark rates was “unavoidable.”
“I made the judgment purely on economics,” Chang, Barclays Plc’s Chief China economist in Hong Kong, said in an interview. “It’s not because I talked to someone or know someone. When I started to make rate calls in 2010, I didn’t know anyone at the PBOC.”
So, if your question is whether she’s someone whose opinion matters when it comes to predicting benchmark cuts out of the PBoC, the answer is “apparently so”.
Of course Barclays is hardly the only bank expecting more easing. The question isn’t whether the PBoC will continue to pull levers, but rather what levers they’ll ultimately pull. Most economists do not see a benchmark cut in 2019, let alone in H1.
One question worth asking is whether a cut to the benchmark rate would be counterproductive from a signaling perspective. That is, what would it say about what the PBoC thinks regarding the likelihood of stabilization in the economy if they pull the trigger on the benchmark rate?
On the other hand, Chang argues that stronger signaling is exactly what’s needed. “Following four RRR cuts in 2018 and another front-loaded cut in early January, the market has already priced in more RRR cuts in 2019, suggesting the marginal boost to sentiment and activity from further RRR cuts would likely diminish as more cuts are delivered as expected”, she writes.
It is hard to argue with that. The idea that China has reached the point of diminishing returns when it comes to juicing markets with RRR cuts is widely accepted and when you throw in the lack of efficient policy transmission, you end up wondering whether more RRR cuts might be largely pointless unless paired with something more aggressive.
Finally, note that the Fed’s dovish pivot presumably gives the PBoC some cover to ease as it means the monetary policy divergence is no longer being pushed wider by Jerome Powell.
In any case, this is clearly something to watch. If Chang is proven right again, it would seemingly bring us closer to the “kitchen sink” moment for China when it comes to pulling out the stimulus bazooka.