Will It Be Enough?

Will it be enough?

That’s the question on the minds of macro watchers as two of the three heavyweights (the Fed and the ECB) get set to join the RBA, RBNZ and a hodgepodge of emerging market central banks including the RBI, CBT, CBR, BI and the BOK, in cutting rates.

Clearly, the prospect of a coordinated, global dovish pivot has buoyed risk assets in 2019, as the reinvigorated hunt for yield turbocharges another carry mania and pushes investors out the risk curve.

The issue, as ever, is whether the proximate cause for the dovishness (slowing global growth and the specter of disinflation) will eventually manifest itself in an outright downturn, at which point bad news will cease to be “good”, as markets will come to fear that the monetary policy response will be insufficient to avert a recession. The risk of that outcome is heightened by the “ammo problem“.

At the end of the day, we all know that the only economy with the firepower to rescue the cycle for certain is China, the engine of global credit creation. “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”, JPMorgan’s Marko Kolanovic wrote back in March.

But there are problems, not least of which is that Donald Trump is working hard to kneecap Beijing. While there’s an argument to be made that the tighter Trump turns the screws, the more incentive China will have to deploy the kind of “kitchen sink” stimulus the world really needs, a more straightforward take on things is simply that the US president’s trade war and insistence on calling Chinese stimulus evidence of cheating and “manipulation”, are crippling the Chinese export machine and constraining Beijing’s ability to rescue the global economy, respectively.

Trump’s antagonism may also be leading China to adopt stimulus measures that are more inward-looking, to the detriment of the country’s regional trading partners, who would normally benefit from a Chinese reflation push.

Finally, the monetary policy transmission channel in China is clogged and there are concerns that it’s not the supply of credit that’s the problem, but rather demand for credit.

Read more: China, Credit Growth And Diminishing Returns

Jitters about China’s capacity and willingness to reflate have dogged the bull thesis for months. Barclays, for instance, has repeatedly suggested that China likely won’t ride to the rescue like they did in 2016. (That didn’t stop the bank from eventually adopting “equity melt-up” as their base case, though.)

“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”, Barclays’ Maneesh Deshpande wrote in March, while explaining the rationale for adopting a “soggy” outlook relative to 2016. “China stimulus has not been as strong and a similar magnitude of fiscal stimulus is unlikely this time”, he added.

Again, Deshpande would eventually turn more bullish (the correct call so far), but the point is, the market is still waiting around on an honest-to-goodness stimulus push from China, arguably the only thing that could turn the economic tide virtually overnight if it were announced with enough fanfare.

Underscoring this is BofA’s Ajay Kapur, who, in the latest installment of “The Inquirer”, cautions that the world monetary base is still shrinking. “In inflation-adjusted terms, the global monetary base growth was contracting 2.1% in June, a bit better than the 4.5% contraction in March, but it’s still shrinking, thanks to quantitative tightening in the US, and from YTD shrinkage in China’s monetary base”, he writes.

That is a problem, because as you can see below, whenever the global monetary base is shrinking, bad things tend to happen:

(BofA)

So, what about Beijing? Well, Kapur notes that China’s monetary base “has shrunk 5.4% YTD, driven by an 8.7% YTD contraction in the PBoC’s ‘Claims on Other Depository Corporations’ and an 8.2% YTD shrinkage in ‘Claims on Others'”.

If you’re wondering how that compares to 2016, the answer is, to use a Trumpism, “not good, not good”. Specifically, the two categories jumped 218% and 173%, respectively in 2016, when the PBoC was, to quote Kapur, “reflating with vigor”.

(BofA)

If you ask Kapur, his colleague Helen Qiao (BofA’s Chief Greater China Economist) is correct that Beijing needs to cut rates. Calls for benchmark cuts (as opposed to targeted measures, OMO cuts and more RRR cuts) have grown louder over the course of the year, and with the Fed set to cut, the PBoC presumably has more leeway.

Trump factors into this, that’s for sure. As Kapur goes on to write, “if the US is following a policy of ‘Optimal Friction’ with China — not too harsh to tip the global economy into recession, but not too soft too far ahead of a US election, but just tense enough to generate enough uncertainty globally for easier monetary policy – domestic monetary reflation in China will need to be a lot more robust than the modest improvement we saw in 2Q2019”.

Fingers crossed, because, again, marginally easier monetary policy (i.e., “insurance”) from developed market central banks predicated on trade frictions may not be enough, especially with rates already so low and balance sheets already bloated.

As the header that rests atop Figure 9 above suggests, what’s needed is “robust reflation” from Beijing – and not just for China’s sake, but for the sake of the global cycle.

(BofA)