Conclusion: The latest round of Chinese economic data suggests inflation remains a headwind and that a reining in of credit expansion and additional interest rate hikes are in China’s intermediate future. Further, the data is supportive of our assertion that QE2 will incrementally slow global growth.
Position: Long Chinese Yuan (CYB); Long the U.S. Dollar (UUP); Short U.S. Equities (SPY)
Chinese November inflation data came in hot [again] over the weekend. CPI accelerated to a 28-month high of +5.1% YoY and PPI also quickened substantially to +6% YoY – a +100bps sequential uptick. 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) – a term we aptly named Quantitative Guessing.
While economists continue to 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 or U.K. CPI, global bond yields, or the CRB Index, which just hit a new YTD high yesterday.
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 12/10) , restricting home loans, forcing banks to hold more FX, price controls, supply rationing 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 in 1H11.
Looking at real 1-year deposit rates, we see that inflation is consuming Chinese savings at an accelerating rate. In November, Chinese savers effectively paid a 2.6% tax on their 1Y savings deposits - even with October’s 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 November, climbing +0.3% MoM. Although, on a YoY basis, growth in Chinese Property Prices continued to slow sequentially (+7.7% YoY in November vs. +8.6% in October).
While the pace of YoY growth has been slowing lately, the persistent MoM gains of late 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 564B yuan in November vs. advancing 587.7B yuan in October. While the second-derivative slowdown is welcomed by Chinese officials, the rate of growth in November far exceeds the average monthly growth needed throughout November and December to achieve China’s official loan growth target of +7.5 trillion yuan ($1.1 trillion) for full-year 2010 (+308.9B yuan). As a result, new loans must not exceed 53.8B yuan in December in order for the target to be met – a low not seen since October ’06!
All in all, 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. The global commodity reflation brought on by Quantitative Guessing further supports our conclusion 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 QG, 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 consumers).
An interesting anecdote there is that Kunming, the capital of China’s Yunan province, recently ordered five retailers including Wal-Mart to report and justify price increases two days before the changes. Should price controls accelerate on the margin, look for retailers exposed to China to suffer margin compression in 1H11 as topline growth potentially slows (vis-à-vis slowing GDP growth).
In turn, elevated inflation readings will continue to lead to further tightening globally, which will weigh on global growth in 2011. 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]