Conclusion: The most recent batch of Chinese economic data supports the recent strength in Chinese equities and concerns that the government may have to induce further tightening to cool inflation. Further analysis shows that China may ultimately prove to be content with the current reading from a policy standpoint, opting to allow yuan appreciation to quell inflation going forward.
Position: Long Chinese equities (CAF); Long Chinese yuan (CYB)
As we anticipated, the Shanghai Composite has rallied 13.8% off its July 5th low on the strength of now-confirmed re-accelerating economic data. The supportive bullish data points include:
- Industrial Production growth re-accelerated sequentially to +13.9% y/y in August versus +13.4% in July;
- Retail Sales growth re-accelerated sequentially to +18.4% y/y in August versus +17.9% in July;
- Money Supply growth re-accelerated sequentially to +19.2% y/y in August versus +17.6% in July;
- and Loan Growth re-accelerated sequentially to 545.2 billion ($80B) yuan in August versus 532.8 billion yuan in July.
While these data points are supportive of a moderation of the broader slowdown within the Chinese economy, they do raise concern about the potential for incremental monetary tightening when taken in context of the latest inflation data.
CPI accelerated to +3.5% y/y in August – the highest increase in 22 months and well above the government’s full year target of 3%. Driven by higher food costs, the 3.5% August gain is 125bps greater than China’s benchmark one-year deposit rate. The negative real interest rate setup is eroding the value of savings deposits as well as forcing some monies into real estate in order to earn a rate of return (investment in real estate development accelerated sequentially to +34.1% y/y in August versus +33% in July).
Chinese property prices, while down sequentially in August on year-over-year basis for the fourth consecutive month (+9.3%), have failed to make headway in the desired direction on a month-over-month basis for the past two months (flat in July and August). This has some investors worried that China could take further steps to cool the property market, including stopping loans to real estate developers, compulsory lowering of home prices, and a ban on third home purchases, according to a report from 21st Century Business Herald dated 9/8.
Further, the acceleration in CPI, loan growth and the marked acceleration in money supply could suggest one of two things going forward. The first is that China may want to clamp down incrementally on its monetary policy should inflation continue to hover meaningfully above target. CPI, however, has averaged only 2.78% y/y in the year-to-date, so there is some headroom remaining for China to be flexible in its monetary policy going forward. On the flip side, Chinese loan growth at 5.72 trillion yuan YTD has only 1.78 trillon yuan of headroom left, which means loan growth must average 445 billion yuan per month through year-end if China is not to exceed its full year target of 7.5 trillion yuan. To put this in context, loan growth in China hasn’t been less than 500 billion yuan on a monthly basis since December of last year.
A second way to look at the acceleration in loan growth is that China could, in fact, be relaxing its previously-established lending ceiling to accommodate demand from the business sector in order to support domestic demand in light of slowdowns in Europe and the U.S. Moreover, the recent uptick and above-target annualized rate of loan growth may also be reflective of China’s recent mandate that banks transfer off-balance sheet loans back on to their books. Knowing full well that a lack of securitization will likely cause Chinese bank’s balance sheets to expand, China may be content to allow the 7.5 trillion yuan target in loan growth to be breached by year end.
Lastly, and shifting gears a bit, we want to highlight the August trade data out of China and how it relates to global commodity markets. Year-over-year Import growth accelerated sequentially in August (+35.2%) for the first time since March, which has been supportive of the oil and copper price of late, including crude oil’s recent TREND line breakout.
All told, China’s August economic data has been supportive of equity prices both domestically and globally. Furthermore, the accelerating inflation data has been supportive of the People’s Bank of China allowing the recent strength in the yuan, which today reached the highest level per dollar since the central bank unified official and market exchange rates at the end of 1993 (6.7435). Considering, China is likely to resist the urge to aggressively combat inflation by raising interest rates, and we expect the recent rally to continue as China seeks to decouple its growth prospects from its foreign counterparties by supporting domestic consumption. We also expect the yuan to continue to appreciate under its own merits, despite increased pressure from U.S. Congress to impose further trade sanctions.