Tag Archives: China

Plan B

Global and US equity markets are hitting new all-time highs at an almost metronomic rate while the VIX continues to hover around a historically-low 11. Moreover, major currencies have remained within narrow ranges in the past couple of months.

Rising global economic activity, still accommodative central bank monetary policy, a historically average crude oil price and increasingly realistic prospect of US tax cuts, among others, continue to buoy global financial markets and tame asset price volatility.

Financial markets have seemingly largely ignored macro, political and geopolitical risks which include 1) monetary policy uncertainty and risk of central banks “getting it wrong”, 2) the impact on emerging markets from higher rates and stronger funding currencies, 3) the shaky underpinnings of global economic growth and 4) political uncertainty in Europe.

The question is whether governments and central banks have a Plan B to reflate their economies and/or support financial markets in the event of an exogenous shock to global growth and/or sharp correction in global financial markets.

The willingness of the private sector in developed markets to borrow more in order to fund economic activity would likely be greatly tested given already high levels of indebtedness and I would not expect corporates or households to be the main source of reflation.

Similarly, the ability and willingness of developed central banks to cut policy rates further and re-start QE programs would be limited in my view.

Precedent suggests that central banks in emerging markets, including China, would likely use considerable FX reserves of around $8trn to slow, if not stop, any shock-induced, rapid and/or sustained depreciation in their currencies.

However, aggregate data mask significant country-side variations while large percentage changes in FX reserves tell us little about their absolute size.

Governments in developed economies could ultimately take over from central banks in a more pivotal role while the governments of China and other Asian economies have repeatedly shown their willingness and scope to use a broad arsenal of measures. Read more

Chinese PMI very sensitive to underlying economic activity

The Federal Reserve has 23 more days worth of data and market developments to analyse before its policy meeting.

China’s official and (unofficial) Caixin manufacturing data for May will be released tomorrow and Friday before the usual deluge of monthly economic indicators. Markets tend to give weight to the early release of PMI data in the world’s second largest economy and the question is whether this is justified.

Looking at data for the past decade, there was a good correlation up till about 2012 between China’s official manufacturing PMI and exports, imports, industrial output, retail sales and GDP, with the added advantage of the PMI leading by a couple of months. However, since then these correlations on the surface appear to have broken down, even if we use the sub-components of headline PMI.

The main issue is seemingly one of calibration. Since 2012, the official manufacturing PMI has only fallen marginally in a narrow 49.0-51.7 range while monthly economic indicators have weakened considerably. If we shorten the time scale, the PMI’s correlations with monthly data again look reasonable.

Markets need to take into account this increased sensitivity of the PMI data, as small moves may ultimately be associated with significant changes in underlying economic activity.

Even so, the official manufacturing PMI has seemingly over-estimated China’s economic strength in recent months. An alternative view point is that monthly economic indicators are about to rebound quite sharply.

The unofficial Caxin manufacturing PMI data – which have been more volatile than the official measure – and the official non-manufacturing PMI have even over longer time-frames been somewhat better correlated with monthly economic indicators. They too point to a rebound in economic activity in coming months.

Please see Appendix for complete set of correlation charts.

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Should China consider renminbi revaluation?

The causes behind the current meltdown in global equities, commodity prices and EM currencies are complex, inter-connected and at times self-reinforcing. But at the heart of the problem lies the inability of policy-makers from Washington to Beijing to engineer a more robust path for economic growth in which the private sector can believe in. This problem, which is largely structural in my view, has been compounded by cyclical challenges including stretched positioning in riskier assets and historically weak equities in August, as well as country-specific concerns in Malaysia, Brazil and Russia to name but three. Read more