Conclusion: The latest Chinese economic data suggest China may continue with its latest round of tightening measures, as inflation and speculation continue to be a concern. Further, we are starting to see confirmation that QE2 will incrementally slow global growth.
Position: Long Chinese Yuan (CYB); Long the U.S. Dollar (UUP); Short U.S. Equities (SPY); Short Emerging Market Equities (FFD)
Chinese October inflation data came in hot this morning. CPI accelerated to a 25-month high of +4.4% YoY and PPI also quickened substantially to +5% YoY. In line with our call since late-August, we’re seeing more confirmation of accelerating inflation globally as a result of the Fed’s weak-dollar policy (QE2). Moreover, we’re seeing central bankers across the globe lash out against Quantitative Guessing, and judging by this morning’s data release, it’s no surprise that China has been the leader in anti-QE rhetoric of late.
While economists could spend hours debating whether China’s “artificial devaluing” of the yuan is perpetuating inflation within its borders, the real truth that matters to market practitioners is that inflation is accelerating globally, across a spectrum of currency policies. Don’t take our word for it, however; pull up a chart of Brazilian, Indian, or Korean CPI (just to name a few countries).
Turning back to China specifically, we are inclined to suspect further tightening may be on the horizon. China has been varied in its efforts to combat inflation and speculation YTD, including raising bank reserve requirements (as recently as yesterday) , restricting home loans, forcing banks to hold more FX, and raising interest rates (10/19). Despite these measures, we feel China may be running out of room for further “cuteness” and that additional interest rate hikes are on the way.
Looking at real 1-year deposit rates, we see that inflation is consuming Chinese savings at an accelerating rate. In October, Chinese savers effectively paid a 1.9% tax on their 1Y savings deposits - even with the recent 25bps rate hike factored in.
Considering that inflation has been, on the margin, eroding China’s high household and corporate savings (a combined 42.2% of GDP), it’s no surprise to see that China continues to struggle to rein in property prices as those savers turn to real estate investment on the margin. National Property Prices (70 cities) continued to grow in October, climbing +0.2% MoM. While the pace of YoY growth has been slowing lately (+8.6% YoY in October vs. +9.1% in September), the absolute level of YoY growth and the continued MoM gains continue to defy China’s efforts to dampen speculation in its real estate market. Further resiliency of property prices will likely necessitate incremental rate hikes or the implementation of the oft bandied about national property tax trial.
Further compounding China’s inflation woes is the rate at which new loans are accelerating, gaining 587.7B yuan in October vs. advancing 595.5B yuan in September. While the second-derivative slowdown is welcomed by Chinese officials, the rate of growth in October far exceeds the average monthly growth needed throughout 4Q10 to achieve China’s official loan growth target of +7.5 trillion yuan ($1.1 trillion) for full-year 2010 (+402B yuan). On a positive note, new loans do show a bit of seasonality and typically slow into year-end, so the +309B yuan average needed in November and December to meet the target is not as big of a stretch as the headlines make it appear to be.
Nevertheless, we feel the confluence of inflation eroding savings (which causes Chinese savers to speculate with their assets on the margin) and robust loan demand will continue to put upward pressure on Chinese inflation data, absent any meaningful policy changes. Layer on the global commodity reflation brought on by Quantitative Guessing and it’s evident to us that further rate hikes may be on the horizon in China.
It’s important to keep in mind that China is not alone in its bout with inflation. As Bernanke and the Fed continue to pursue a weak-dollar policy via QE2, there’s no reason to expect commodity prices to come down meaningfully in the near term, which will put upward pressure on both core and headline CPI readings globally (COGS inflation will likely get passed through to citizens, lest firms suffer margin compression). In turn, that will continue to lead to further tightening globally, which will weigh on global growth going forward. Keep the equation below in mind as you ponder the real effects of QE2 vs. what the Fed would have you believe:
QG = inflation [globally] = monetary policy tightening [globally] = slower growth [globally]
No wonder Bernanke is playing one vs. nineteen at the G20 Summit.