Monthly China Macro Update: Speed kills
- 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
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
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.
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.
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
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
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
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
- 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.
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Andrew Bresler is deputy director of global sales trading APAC at Saxo Bank, Singapore.
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