The latest activity data out of China (for July) disappointed anxious markets.
Retail sales missed badly, fixed asset investment was a shade below expectations and industrial output growth printed just 4.8%, well below the 6% consensus was looking for and the lowest read in 17 years.
You could easily argue that China’s lackluster July activity data tipped the first domino in a chain reaction that ended up inverting the US 2s10s and pushing the Dow to its worst day of 2019 on Wednesday.
While documenting the July activity numbers out of Beijing, we noted that the misses came hot on the heels of data out last week which showed PPI deflation arriving in China for the first time since 2016. We also reminded folks that credit growth data out Monday came up woefully short too.
All in all, the balance of evidence clearly supports the case for easing, both on the monetary and fiscal fronts in China.
There were at least a couple of notes out Wednesday that made the same appeal, one of which came from the desk of SocGen’s Wei Yao, who runs through a breakdown of the industrial output, FAI and retail sales numbers for July. Here’s a great summary that captures the marked deceleration in manufacturing:
By sector, manufacturing output growth moderated even more pronouncedly from 6.2% to 4.5%, while mining production growth also fell from 7.3% to 6.6%. The weakness in manufacturing output was driven by electric machinery, ferrous metal processing and computer & electronics. The last one probably had a lot to do with escalating US-China trade tensions as this is the biggest exporting sector to the US and exporters are increasingly looking to diversify their production base outside of the mainland. Meanwhile, general and special equipment manufacturing, which usually reflects infrastructure momentum, also moderated. And auto output, in contraction since last winter, worsened again in July.
She continues, noting that within FAI, infrastructure investment growth dove to 3.6% from 7.0% in June. That, Wei says, “was disappointing given that the government already accelerated the issuance of special local government bonds over the past two months and in June allowed them to be used as equity capital in selected projects”. Remember that initiative? Chinese shares rallied the day the Finance Ministry made the announcement, which loosened the rules around how local governments can spend the proceeds from special bond sales. The decision was designed to bolster infrastructure spending. Now, SocGen frets that rising default rates on local government financing vehicle debt “have proved to be a major hurdle for infrastructure ramp-up”. Oops.
Wei also flags a slowdown in property investment and says “the more forward-looking indicators do not bode well for future trends, with growth in housing starts falling sharply to 6.6% from 9.1% and land transaction contracting 36.8%”.
She goes on to remark that the slowdown in retail sales bodes ill for domestic demand, especially considering the uptick in surveyed unemployment, both points we made in the minutes after July’s activity data crossed on Wednesday morning in China.
Moving on to the PPI deflation point (see linked post above for the full story on that), SocGen cautions that iron ore prices “have again dropped sharply in August, pointing to more deflation momentum ahead [while] producer prices in downstream industries remained subdued [especially] in computers and electronics, which are highly exposed to external demand”. The bank echoes other desks in suggesting that the uptick in CPI doesn’t necessarily present an obstacle to easing given the concentration in food prices.
And then there’s credit growth. Total social financing and new yuan loans both came up short in July and as noted on Monday, the data betrayed a broad-based slowdown in shadow financing, as undiscounted bank acceptance bills, entrusted loans and trust loans all shrank. That, we suggested, was due both to lackluster credit demand and to tighter interbank markets, both points that SocGen’s Wei underscores in her assessment.
So, despite Beijing’s efforts to stick with the program in terms of using targeted measures and avoiding the kind of indiscriminate, “kitchen-sink-type” easing that could risk blowing bubbles, waiting any longer might not be advisable.
As SocGen puts it, “Saving easing for a rainy day? But it is already drizzling”.
“While we applaud Beijing’s commitment to keeping leverage under control, more policy stimulus — especially from the formal fiscal side — that would help the economy through a difficult time is also fully justifiable”, the bank writes, adding that “on the monetary policy front, the PBoC has been refraining from a broad-based stimulus since spring, but the targeted measures are clearly insufficient to stabilize even credit growth, never mind the real economy”.
So, in addition to more targeted RRR cuts and TMLF, Beijing needs to “resume headline easing”, SocGen declares.
Remember, this is complicated by the fact that the PBoC is in the process of trying to simplify the policy framework. We talked at length about that in “As PBoC Warns Of ‘Market Chaos’, Here’s What’s Next For Chinese Monetary Policy“. Wei acknowledges as much and, like some others, suggests all of this can be rolled up into a broad easing push this fall. To wit:
Now that the RMB exchange rate is less constrained by the arbitrary level of 7 vis-à-vis the dollar, the option of lowering interest rates has become even more viable. We maintain our call that the PBoC will start cutting interest rates on its open market instruments in 2H19, including reverse repos, SLFs and MLFs. And if this happens, it will be a good opportunity for the PBoC to announce a new policy rate and to introduce a new mechanism for banks to price lending.
Note the irony. Now that the PBoC has let the yuan fall through what was, frankly, a largely meaningless threshold, Beijing no longer has to worry about whether headline easing will make that threshold harder to defend.
In other words, letting 7 fall makes it easier for China to cut rates, which is something that won’t sit well with a certain US president who spent a lot of time on Twitter Wednesday talking about how China is “eating the Tariffs with the devaluation of their currency and pouring money into their system”.