Article / 05 December 2017 at 1:51 GMT

Monthly China Macro Update: Speed kills

Deputy Head of sales Trading Asia Pacific / Saxo Capital Markets
Singapore

  • Authorities in Beijing are following up talk with action on stamping out leverage
  • China's economic activity continues to show signs of cooling
  • The bond rout appeared to gather momentum with 10 year yields hit 3 year highs
  • Rapid deleveraging, rising yields risk an accident with credit impulse down 25%y/y
  • China's growth risks are heavily tilted to the downside
By Andrew Bresler

Evidence is growing that the authorities in Beijing are serious about deleveraging the Chinese economy; a process that can’t come soon enough as debt is expected to climb to nearly 300% of GDP by 2022, according to the IMF. On the surface – while alarming – with a growth rate of 6.7% it can be argued that this level of debt is sustainable.

China data releases
nnn
 

However, as my colleague Christopher Dembik points out in his monthly macro outlook (Macro Outlook: Are we too optimistic on global growth?), the amount of growth China is getting per unit of credit has fallen precipitously, now needing 2.5 units of credit to generate 1 unit of growth, from 1-to-1 pre-GFC. Essentially, to maintain the 6.5% growth China needs more and more credit to do so.

nnn


















China watcher Michael Pettis warns that China’s growth miracle has run out of steam, and that the nation has only met its GDP targets by allowing debt to surge. Photo: Shutterstock

I noted in the conclusion to last month’s China Macro monthly that as China pivots from old to new, it’s possible that growth momentum is maintained and an accident is avoided, but also highlighted that there could not have been a better opportunity for president Xi Jinping to choose harder, faster reforms than right now. The recent evidence suggests that this may in fact be happening faster than the market consensus dictates and this raises the risk of an accident. As I was told early in my career, speed kills, not direction.

Slowing growth

October activity again pointed to a slowing of the economic growth trajectory in China with a downward trend in: industrial production, fixed asset investment, retail sales and the prices of tier one properties all headed lower. (See below.)

Fixed asset investment (left) and retail sales
nnn
 Source: Bloomberg. Create your own charts with SaxoTrader; click here to learn more. 


In fact, economic activity has consistently been surprising to the downside, such that the Citi economic surprise index is currently deeply in negative territory and at the lows of the year. 

Since the 19th Party Conference China held in October, bond yields have skyrocketed climbing from 3.6% on 10 years at the start of October to over 4% during November, the highest rates since before the credit splurge of late 2015 early 2016. It’s little wonder then that the market is sitting up and taking notice as the bond rout gathers pace.

Citi economic surprise index (left) and 10 year bond yield

nnn
Source: Bloomberg

Efforts by the authorities to curb leverage in the Chinese financial system continued to gather pace in October, with regulators led by the People's Bank of China implementing the toughest regulations to date on the $15 trillion dollar asset management industry specifically designed to curb the once rampant shadow banking sector. These curbs restrict the buying of bonds with borrowed money and off-balance sheet lending to corporate clients. They follow a wave of pointed attacks on other areas of overleverage within the economy, specifically the state owned enterprises and the property sector. As has been highlighted in previous macro monthlies, the authorities’ measures have begun to bite.

If this wasn’t confirmation enough, outgoing PBoC chairman Zhou Xiaochuan followed up the curbs with a lengthy article in the authorities' squawk box, The People’s Daily, warning about the risk of leverage and the need for curbs, specifically those sitting as hidden debts within the financial sector.

Repeated warnings from the highest levels, coupled with actions being put to practice, has rightfully caused some consternation in markets with the CSI 300 Index tumbling near 3% – it’s largest fall in 17 months –  and the bond rout gathering steam, sending ripples around global markets in late November. Digging deeper into some onshore names, China cyclical names have been on the receiving end of a drubbing as traders move away from those stocks most exposed to a cyclical downturn. Looking across the space, names in shipping, construction, power, railway and resources are all down significantly over the past month with some losing double digits in November.


China Industrial Production data (left) and Price of Tier 1 Cities   
nnn
Source: Bloomberg

Market begins to take notice

Respected China watcher, Michael Pettis, a professor at Beijing University and associate of the Carnegie Endowment, wrote in the Financial Times in late November: “China’s growth miracle has already run out of steam. It is only by allowing debt to surge that the country is able to meet its GDP targets. This may be why President Xi Jinping has been eager to stress more meaningful goals, such as increasing household income.”

While there have been a few nervous jitters, the market, however, seems yet to be on board with the idea that China may be slowing rapidly. Economists forecast that GDP growth will slow to 6.5% in 2018 from 6.8% this year. The same cyclical stocks that have been so under pressure for the past month as the cyclical slowdown becomes more evident still have analyst 12-month price appreciation expectations of roughly 20%-30% on average.

Given so much of China’s 6.7% GDP has been fuelled by an explosion of credit, surely the most worrying final piece of all of this must be the 25% y/y fall in the Chinese credit impulse, a tumble to new post crisis lows. Our economists believe that the credit impulse leads the real economy by 9-12 months, meaning Q1 should start to see an acceleration of growth lower.

China credit impulse
nnn























A lower China outlook is a lower global outlook, and with the market relatively sanguine on the China slowdown its worth at least exploring a worst case option. The rapid speed of the bond rout acceleration after the 19th Party Conference, the high build-up of credit and authorities seemingly hell bent on rapidly stamping out financial leverage is not without risks.

Growth risks for China are in my opinion firmly tilted to the downside. Marry that view with a very late-cycle US recovery and a market buoyant on global growth prospects as they become increasingly broad-based and you have the recipe for a potentially tricky start to 2018 that warrants care.


nnn































Monthly Commentary

  • Asian currencies generally performed in November as USD weakness was a dominant theme.
  • The biggest mover for the month was that of the KRW which has rallied over 6% since the September highs as good economic activity puts the Bank of Korea on path to be the first Asian central bank to raise rates.
  • India continues to attract strong inflows as economic activity demonstrates that the worst is behind the economy following demonetization and the implementation of GST.
  • IDR has been a notable underperformer in the region as the prospect for higher rates in the US has made bond investors nervous. A persistent reserve accumulation bid from the BI has meant IDR has struggled to perform. However, an implied 4.6% yield from the 1 month forward offers an attractive opportunity.
                                                                                  
– Edited by Robert Ryan

For more on forex, click here.

Andrew Bresler is deputy director of global sales trading APAC at Saxo Bank, Singapore.

NON-INDEPENDENT INVESTMENT RESEARCH DISCLAIMER

This investment research has not been prepared in accordance with legal requirements designed to promote the independence of investment research.
Further it is not subject to any prohibition on dealing ahead of the dissemination of investment research. Saxo Bank, its affiliates or staff, may perform services for, solicit business from, hold long or short positions in, or otherwise be interested in the investments (including derivatives), of any issuer mentioned herein. None of the information contained herein constitutes an offer (or solicitation of an offer) to buy or sell any currency, product or financial instrument, to make any investment, or to participate in any particular trading strategy.
This material is produced for marketing and/or informational purposes only and Saxo Bank A/S and its owners, subsidiaries and affiliates whether acting directly or through branch offices (“Saxo Bank”) make no representation or warranty, and assume no liability, for the accuracy or completeness of the information provided herein.
In providing this material Saxo Bank has not taken into account any particular recipient’s investment objectives, special investment goals, financial situation, and specific needs and demands and nothing herein is intended as a recommendation for any recipient to invest or divest in a particular manner and Saxo Bank assumes no liability for any recipient sustaining a loss from trading in accordance with a perceived recommendation.
All investments entail a risk and may result in both profits and losses. In particular investments in leveraged products, such as but not limited to foreign exchange, derivatives and commodities can be very speculative and profits and losses may fluctuate both violently and rapidly.
Speculative trading is not suitable for all investors and all recipients should carefully consider their financial situation and consult financial advisor(s) in order to understand the risks involved and ensure the suitability of the situation prior to making any investment, divestment or entering into any transaction.
Any mentioning herein, if any, of any risk may not be, and should not be considered to be, neither a comprehensive disclosure or risks nor a comprehensive description such risks.
Any expression of opinion may be personal to the author and may not reflect the opinion of Saxo Bank and all expressions of opinion are subject to change without notice (neither prior nor subsequent).
This communication refers to past performance. Past performance is not a reliable indicator of future performance. Indications of past performance displayed on this communication will not necessarily be repeated in the future.
No representation is being made that any investment will or is likely to achieve profits or losses similar to those achieved in the past, or that significant losses will be avoided.
Statements contained on this communication that are not historical facts and which may be simulated past performance or future performance data are based on current expectations, estimates, projections, opinions and beliefs of the Saxo Bank Group. Such statements involve known and unknown risks, uncertainties and other factors, and undue reliance should not be placed thereon.
Additionally, this communication may contain ‘forward-looking statements’. Actual events or results or actual performance may differ materially from those reflected or contemplated in such forward-looking statements. This material is confidential and should not be copied, distributed, published or reproduced in whole or in part or disclosed by recipients to any other person.
Any information or opinions in this material are not intended for distribution to, or use by, any person in any jurisdiction or country where such distribution or use would be unlawful. The information in this document is not directed at or intended for “US Persons” within the meaning of the United States Securities Act of 1993, as amended and the United States Securities Exchange Act of 1934, as amended.
This disclaimer is subject to Saxo Bank’s Full Disclaimer available at https://www.home.saxo/legal/disclaimer/saxo-disclaimer

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Tradingfloor.com permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Tradingfloor.com and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Tradingfloor.com is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Tradingfloor.com or as a result of the use of the Tradingfloor.com. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. When trading through Tradingfloor.com your contracting Saxo Bank Group entity will be the counterparty to any trading entered into by you. Tradingfloor.com does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of ourtrading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws. Please read our disclaimers:
- Notification on Non-Independent Invetment Research
- Full disclaimer

Check your inbox for a mail from us to fully activate your profile. No mail? Have us re-send your verification mail