CHINA: WHY DID THE PBOC CUT? WILL IT EVEN MATTER?

Takeaway: The PBoC’s surprise rate cut confirms our bearish thesis on the Chinese economy, but may portend brighter days ahead.

Chartreuse and Spoos: The Global Central Planning Spree Continues

As you can probably tell by the overnight action in the spoos, a central bank in Asia eased monetary policy. This time, it was China – i.e. the economy responsible for 16% of global GDP and 30% of global GDP growth (on a PPP basis). Yes, the same China where 2014 Real GDP growth is tracking at the slowest pace since 1990!

 

From a forward-looking perspective, this is a good thing only if it signals a sustained move away from the “proactive fiscal policy and prudent monetary policy” they’ve been guiding to and implementing for over two years now. Recall that amid incessant cries for Western-style monetary easing, the PBoC has refrained from cutting interest rates since July of 2012 (excluding the removal of the lending rate floor). It has not [broadly] lowered RRRs since May of 2012.

 

CHINA: WHY DID THE PBOC CUT? WILL IT EVEN MATTER? - China Nominal Interest Rates

 

In and of itself, this rate cut will hardly do anything to arrest the rate of decline in Chinese economic growth; nor will it offset the “increasing downward pressure” upon the Chinese economy over the NTM, as most recently reiterated Xu Shaoshi (head of the National Development and Reform Commission) just two days ago.

 

Chinese growth is effectively crashing at this point. Our model points to a continued slowdown of Real GDP to +7.1% YoY in 4Q – and that’s being polite (i.e. conceding their made-up numbers). The reality is that Chinese growth is far shy of that number, making the 2nd derivative impact much more severe for economies and businesses that rely on Chinese demand. Pull up a 2Y chart of Standard Chartered (STAN) if you want the real story on Chinese growth. 

 

So Why Cut Now?

There are two primary reasons why the PBoC surprised everyone by cutting rates today (-25bps on the benchmark household deposit rate; -40bps on the benchmark lending rate):

 

  • Economic growth – which had already been slowing precipitously, as evidenced by the sea of red in the table below – fell off a cliff in October. This is most easily confirmed by the rate of change in Total Social Financing growth and Macau’s mass business, which was down -8% YoY (from +15% in September). That was the first annual decline in mass revenues in over five years!
  • Amid increasingly large capital outflows (see: declining FX reserves and negative “hot money” flows) and trending disinflation, the real cost of 1Y capital in the Chinese banking system has actually risen to fairly high level of late, rising to roughly 1.4% from ~0% at the start of the year.

 

CHINA: WHY DID THE PBOC CUT? WILL IT EVEN MATTER? - CHINA High Frequency GIP Data Monitor

 

CHINA: WHY DID THE PBOC CUT? WILL IT EVEN MATTER? - China Iron Ore  Rebar and Coal YoY vs. GDP

 

CHINA: WHY DID THE PBOC CUT? WILL IT EVEN MATTER? - China Real Interest Rate

 

Again, the PBoC’s decision to cut rates today makes a ton of sense to us, given China’s sustained #Quad4 setup, which calls for a dovish response from fiscal and monetary policymakers. We just didn’t see it coming given their official guidance; it's worth noting that Beijing is notorious for sticking to the script.

 

CHINA: WHY DID THE PBOC CUT? WILL IT EVEN MATTER? - CHINA

 

Cyclical Outlook: Still Very Negative, But Potentially Positive

You’ll note that in that our GIP Model has China going into #Quad1 for the first quarter. That’s primarily because of seasonality (fiscal expenditures and credit growth tend to be front-end loaded) and, obviously, very easy comps. That being said, China had these things working in its favor at the start of this year, but obviously the tightening we saw in the early part of 2014 trumped that setup (to the downside).

 

CHINA: WHY DID THE PBOC CUT? WILL IT EVEN MATTER? - China GDP Seasonality

 

A continued “recovery” in the Chinese property market – which had been truly crashing – is also supportive of any positive 2nd derivative delta for the Chinese economy in 1H15.

 

CHINA: WHY DID THE PBOC CUT? WILL IT EVEN MATTER? - CHINA Property Market Monitor

 

It’ll be interesting to see if the rebound in property development (read: fixed asset investment) is actually sustainable amid home price deflation accelerating to the downside on a trending basis. For now, it’s too early to tell; what we do know is that Chinese policymakers are very concerned about this segment of the economy and have ratcheted up support for the sector in recent months.

 

Investment Conclusions

All told, the PBoC’s surprise rate cut confirms our bearish thesis on the Chinese economy, but may portend brighter days ahead from a cyclical perspective.

 

That being said, long-term investors should NOT get involved with any “China recovery” trade that may percolate from this. China’s structural economic imbalances and official rebalancing agenda imply continued slowing over the long-term TAIL.

 

Feel free to ping us w/ any follow-up questions. Have a great weekend,

 

DD

 

Darius Dale

Associate: Macro Team


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