Conclusion: Recent price action across Chinese interest rate and fixed income markets are siding with the latest economic data that monetary easing is forthcoming. That said, however, our analysis puts any material easing in the form of rate cuts and/or large-scale fiscal stimulus at least 1-2 quarters away (assuming no new Federal Reserve policies to inflate are introduced) – a long time to wait and [potentially] a lot of downside to pay in today’s volatile markets.
Continuing recent trends, Chinese October growth and inflation data came in sequentially slower on the margin, which is in-line with our expectations. Looking to the growth data specifically, we saw retail sales slow marginally to +17.2% YoY, industrial production slow marginally to +13.2% YoY, and YTD fixed assets investment came in flat sequentially at +24.9% YoY.
Turning to the inflation data specifically, Chinese CPI came in at an attractive +5.5% YoY in October, slowing on the margin from a prior reading of +6.1%. Perhaps even more welcoming was the slowdown in producer prices, which slowed -150bps sequentially to +5% YoY in October. This confirms the dramatic easing of supply-side cost pressures we saw in the recent PMI survey(s).
Taken in aggregate, these data points inch China materially closer to cutting interest rates, insomuch that a marked slowdown in inflation must be in the books before Chinese officials can materially loosen monetary policy and ease credit conditions – a necessary catalyst for Chinese growth to rebound in our scenario analysis. To say that there is a glut in supply of anecdotal stories on China’s SME credit crunch and the resultant non-traditional lending would be an understatement at this point. Take the following Bloomberg headline for reference:
“China Credit Squeeze Prompts Suicides Amid Offer to Sever Finger” (11/7)
As always, it’s important to you know where you are in the cycle and headlines like these are helpful in the sense that they suggest to us that the apex of economic pain in China is within reach. As mentioned in previous notes, our algorithms have Chinese real GDP growth bottoming out in 1Q12E within the +8.5%-8.7% range. Nasty fourth quarter data potentially could push that bottom out 1-2 quarters and down 50-100bps, but, for now, that isn’t the most probable scenario and remains outside of our baseline assumptions. Keep in mind, there’s a lot of risk to manage in this high volatility environment, so don’t make the mistake we made this summer of buying China too early! The same message applies to industrial commodities – especially in the context of our King Dollar and Correlation Crash themes.
Again, we cannot stress how important patience will play a factor here in the short-to-intermediate term return profiles of any investments that center on Chinese monetary and/or fiscal easing at this current juncture. Based on our daily grinds through various sources of market commentary, our view is contrary to the near-consensus belief (shared by members of the sell-side and buy-side) of easing sooner-rather-than-later. The snippets below, both of which were published earlier today, frame this setup quite nicely:
“Downside risks from faltering exports and rising housing inventories are building. A broader scale easing is likely to start soon with faster new loan growth and higher budgetary spending on existing government-led investment.”
- Li Wei, a Shanghai-based economist at Standard Chartered Bank
“This is the third month of CPI easing, so investors are now more assured that the trend will continue for the rest of the year. We are now also confident there will be easing by the government.”
- Larry Wan, Beijing-based head of investment at Union Life Asset Management Co., which manages the equivalent of $2.2 billion
No doubt, selective easing has been underway for months now, including, but not limited to: investment public housing, plans to relax SME credit conditions, and supportive changes to the income tax code. This is just the tip of the iceberg. For a real buoy to Chinese [and global] growth, the PBOC needs to cut rates and lower bank reserve requirements. Our analysis of Chinese inflation data and interest rate markets suggests those actions are further out in duration (3-6 months) than consensus is likely hoping for:
Using 2008 as a proxy, when China cut its benchmark household savings deposit rate in early October, we saw five of seven flat-to-down months of annualized MoM CPI growth. In the current cycle, we have seen none. Net-net, inflationary pressure remains much too hot for the PBOC to consider material easing at the current juncture – especially given that containing property prices are to remain a key focus of policy:
"I want to especially emphasize that there will not be even the slightest faltering in the property market curbs.”
- Chinese Premier Wen Jiabao in Russia (11/5-11/6) – the third time in as many weeks he reiterated the government’s tough stance on the property market
Turning to China’s interest rate markets, we are receiving a similar signal of forthcoming monetary easing, albeit to a lesser extent. Using China’s 7day repo rate a proxy for interbank liquidity, the -134bps drop in the month-to-date rhymes with the -45bps day/day drawdown in China’s 1yr sovereign debt yields on the heels of this morning’s CPI release. Inclusive of the latter move, that puts China’s1yr fixed borrowing cost a full -99bps below the benchmark 1yr household savings deposit rate.
Again, using 2008’s first household savings deposit rate cut as a proxy, we saw the PBOC cut rates when this spread was at -77bps (not causal; merely coincidental). That’s encouraging for the “ease now” crowd, but we’d also like to see the aforementioned dramatic move into “positioning” confirmed by the interest rate swaps market as well, which is currently trading -45bps below the 1yr household savings deposit rate – a full 99bps above where it was when the PBOC cut back in 2008.
All told, the recent price action across Chinese interest rate and fixed income markets are siding with the latest economic data that monetary easing is forthcoming. That said, however, our analysis puts any material easing in the form of rate cuts and/or large-scale fiscal stimulus at least 1-2 quarters away (assuming no new Federal Reserve policies to inflate are introduced) – a long time to wait and [potentially] a lot of downside to pay in today’s volatile markets.
Per Merriam-Webster’s online dictionary, to “juke” means “to fake out of position”. As my coach used to tell me when I played defense, “Break down and make the [darn] tackle!” It will pay to acutely manage the TIME and SPACE risk associated with Chinese assets or those assets highly sensitive to Chinese growth over the next one to two quarters.