China is a key driver of the global economic cycle, and monetary and fiscal policy in China are likely to determine this cycle (more so than the Fed).
Either the Chinese economy will have a positive inflection and any kind of Brexit will not derail the global cycle, or if China rolls over, no kind of Brexit will save the global cycle.
Both of those quotes are from JPMorgan’s Marko Kolanovic. The first is from his March 26 note on the yield curve and the second from his March 21 market update documenting the role of diminished liquidity both in the Q4 selloff and the dramatic bounce off the Christmas Eve nadir.
Kolanovic’s observations on China aren’t unique (and he wouldn’t claim that they are), but where possible, there’s utility in quoting Marko on important market dynamics to the extent the weight his name carries helps to drive home and otherwise underscore critical points. And there is arguably no point more critical than the notion that where things go from here depends heavily on China’s credit cycle and, relatedly, Beijing’s success or failure in pulling the myriad monetary and fiscal policy levers at their disposal in the interest not only of shoring up their own economy, but rescuing the global cycle from a brush with recession and disinflation.
This is always the same story. China’s transition to a more sustainable growth model was already a delicate balancing act, as was Beijing’s effort to squeeze leverage out of the country’s labyrinthine shadow banking complex without choking off credit to the real economy. The trade war made the juggling act even more difficult.
In 2019, it’s not just a question of whether there’s a will in Beijing to support the economy with stimulus. It’s also a question of whether there’s a way, given diminishing returns on credit growth, the possibility that demand (rather than supply) is the problem when it comes to credit and, relatedly, a clogged monetary policy transmission channel.
Whether or not China avoids a “hard landing” will arguably be the deciding factor when it comes to whether global growth can inflect.
You might recall that for Barclays’ Maneesh Deshpande, the path forward for US equities hinges to a great extent on China’s credit cycle. He wrote extensively about this late last month. “The central question in our mind is whether the Chinese authorities will embark on a similar rescue operation this time around”, he remarked, referencing Beijing’s efforts in 2016, a year many analysts view as a partial analog to the current environment (indeed, Jerome Powell drew the parallel in Atlanta on January 4, the day it all turned around for risk assets).
Well, in a new piece dated March 28, Deshpande reiterates all of this. He starts by noting the rather precipitous decline in consensus earnings expectations which, as mentioned early Saturday, comes courtesy of the ex-US slowdown. Both non-US growth and non-US earnings peaked last year.
What accounts for the drop-off? For Barclays, it’s all about the Chinese credit impulse.
“In our opinion, the key catalyst for these developments is the waning of the China credit cycle”, Deshpande says, adding that “while the US-China trade war has exacerbated the problem, the China credit cycle presents an independent effect, primarily driven by a self-induced deleveraging by the Chinese authorities as they seek to gradually transition their economy to a more sustainable growth rate.” That, Barclays argues, has “directly” impacted corporate earnings across the globe.
The bank then reiterates what Goldman wrote on Friday evening – namely that the decline in earnings expectations for US corporates is a consequence of large companies’ exposure to the global slowdown via the international revenue channel.
Next, Deshpande draws the 2016 parallel again, on the way to arguing that there are impediments to the same kind of sustainable “V-shaped” recovery we witnessed three years ago. He cites a number of reasons for adopting a “soggy” outlook relative to 2016, including the bank’s base case that “China stimulus has not been as strong and a similar magnitude of fiscal stimulus is unlikely this time.”
In addition to that, Barclays reminds you that back then, the ECB and the BoJ were still easing aggressively, whereas now, both banks are at best constrained in their ability to ease further (although as ever, Kuroda would beg to differ). The bank also flags “political overhangs” from Brexit to the Yellow Vests in France to Italy before delivering the following assessment of the whole “good Trump/bad Trump” dynamic (as SocGen calls it). Here’s Deshpande:
Finally, a big reason for the rally during 2017 was the ‘Trump’ effect, which is clearly absent now. It is highly unlikely that pro-cyclical action can be entertained in the US; while there are hopes that a US-China trade deal will be announced, there is still a risk that the administration escalates trade tensions with Europe and China over automobiles.
The bottom line for Barclays is that currently, equities in the US, the UK and Europe are “fully valued with binary risks.”
What could cause a “melt-up”? Well, four things, Barclays reckons, with the first on the list being a kitchen-sink-type stimulus push out of China. To wit:
In 2016, the Chinese authorities responded to the weakening credit conditions with significant fiscal stimulus, resulting in a rebound in US industrial production as well as 2016 earnings expectations. The central question in our mind is whether the Chinese authorities will embark on a similar rescue operation this time around. While they have implemented a series of measures over the past few months, these are less dramatic… However, the current set of policies are beginning to have an impact and, while a strong V-shaped rebound of the credit cycle is unlikely, for now it does appear to have bottomed.
The other potential “melt-up” catalysts are familiar. Barclays talks about the prospects for a “credible” Sino-US trade pact, an abatement of political tensions in Europe and/or a fiscal stimulus push aimed at reviving growth across the pond. Remember, the size of the cut to the ECB’s euro-area growth forecast caught some off guard this month despite the obvious signs that things are unraveling.
If those are the potential catalysts for a melt-up, what could cause a meltdown?
Here again, the talking points will be familiar, but the major risk Deshpande cites is that the US economy takes a “serious” turn for the worse.
“To be clear, US macroeconomic data has remained relatively resilient and we do not think that there is a chance of an outright US recession this year”, he writes, on the way to cautioning that the bank’s estimates “have moved over the past few months indicating that we are closer to the edge.”
If you ask Donald Trump, there’s only one person to blame if the US economy is indeed rolling over:
Don’t worry – Stephen Moore will fix it.
And on that note, we’ll just leave you with two additional visuals.