Things Just Turned More Serious In China

The outlook for the beleaguered Chinese economy darkened further as trade data for August underwhelmed, threatening to remove one of the only remaining pillars of support for the flagging yuan.

Exports rose just 7.1% last month (figure below), Beijing said Wednesday. That was much slower than the near 13% increase economists expected.

It marked just the second time in nearly two years that export growth has decelerated into the single-digits, the other being April, when the economy was struggling beneath the Shanghai lockdown, which hampered logistics and crippled commerce. Shipments to the US shrank nearly 4% from a year ago last month, the first contraction in 27 months.

“Export softness arrived earlier than expected, it seems, as recent shipping data suggests demand from the US and EU has already slowed,” Zhou Hao, chief economist at Guotai Junan International, remarked.

Imports barely rose and were the weakest since a contraction in August of 2020. Reviving domestic demand is a tall order. The threat of new lockdowns is ever-present and legacy drag from the property curbs continues to weigh on sentiment. Retail sales were very weak in July and credit demand is lackluster. On the bright side, less domestic demand for energy imports helps put downward pressure on commodity prices.

To be sure, exports were expected to falter. Global demand is in jeopardy as recessions loom in advanced economies, where consumers have seen their purchasing power steadily eroded by generationally high inflation. Even in the absence of what counts as runaway price growth in the developed world, consumer preferences shifted away from goods in favor of services as the world learned to live with COVID, even as Xi refused to accept the virus as endemic.

China’s surplus was $79.4 billion last month, well below a record hit in July, when export growth surprised to the upside.

The underwhelming trade figures were insult to injury for the yuan, which is the subject of an increasingly vociferous debate. Yuan weakness, like the tumult roiling currencies the world over, is a (strong) dollar story. But there’s more to it than that. China’s economic fundamentals are deteriorating, the Party’s growth target for 2022 is now a pipe dream (Beijing effectively abandoned it in favor of nebulous allusions to keeping growth in a “reasonable range”), the Chengdu lockdown suggested Xi isn’t persuaded that “COVID zero” is unsustainable, extreme weather threatens to rekindle last year’s power crunch and the policy divergence between the PBoC and the Fed argues against the yuan.

On Wednesday, the PBoC leaned very hard into the fix, setting a stronger-than-expected reference rate for an eleventh consecutive day. The 454-pip disparity was the largest on record (figure below).

Think of that as the PBoC signaling a strong aversion to an unruly pace of depreciation. Xi’s de facto coronation ceremony is next month, and optics are extremely important to the Party. The last thing officials need is a domino effect, where a disorderly slide in the currency further undermines sentiment domestically, triggering an equity selloff.

Still, there’s scant evidence to suggest authorities have their eyes on any specific level, even if some options traders do. Asian-based traders on Thursday said market participants are trying to prevent USDCNY from breaching 7.00, the strike on nearly $5 billion in contracts expiring this week.

“Despite the PBoC’s intent, its signaling is a rather blunt tool to curb CNY depreciation pressure,” BNY Mellon’s Wee Khoon Chong wrote, in a Wednesday note. “Measures that effectively increase funding and trading costs are likely to have greater and more immediate short-term impact,” he added, suggesting the PBoC could resort to more “straightforward” tactics.

“One way is to tighten onshore and offshore funding costs, though this may create unintended consequences and disrupt normal funding operations in the interbank system,” he went on to say. “Another is to invoke the reserve ratio on FX forwards trading.” The PBoC has resorted to that latter tactic twice, once in September 2015 following the prior month’s shock devaluation, and again in August of 2018, in the early days of the trade war. Mizuho echoed the suggestion, but noted it could “discourage FX hedging and may contradict the principle of setting up an FX risk neutral mentality.”

Whatever the case, Wednesday’s trade data didn’t do the currency any favors. The spread between the fix (6.916 on Wednesday) and USDCNY spot (6.9776) is now very wide. I said Tuesday that it wasn’t time to panic about the yuan. I added a caveat: “Yet.”


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One thought on “Things Just Turned More Serious In China

  1. Over the last five decades, China has unquestionably filled the gap for affordably manufacturing American products, and those of other western countries, and grown its economy substantially in the process. China, I imagine, will bet on the “certainty” of Xi’s leadership to help them navigate the rough economic and political seas across the world in the months and years ahead.

    But there’s a meaningful share of trading partners in the world, chiefly in the US, who generally question the trustworthiness and modus operandi of Xi and the CCP. I am hoping we can effectively return a good proportion of the that manufacturing to the US and identify effective manufacturing resources in other countries in parallel, as needed.

    The process of relocating manufacturing of US goods has already begun. It will require months and years. But we know Xi and we know the character of the CCP, which every day grow in their opposition to the west, and their hubris about Chinese economic prowess. China seems to think they can successfully manage their economy and control their people.

    I look forward to seeing ongoing democratic government in Taiwan and rebalanced distribution of manufacturing sources for US goods away from China.

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