China in four acts:
- China-U.S. trade:
- China-U.S. trade negotiations are promising, with expectations that a deal will be struck by the end of March or in April.
- Negotiators have apparently made significant progress, though further distance is still necessary.
- It initially sounded as though the deal was mostly a rehash of familiar promises: buying more soybeans, purchasing more natural gas and lowering Chinese auto tariffs. It now seems as though some of the underlying issues may also be addressed, such as the forced transfer of technology from U.S. firms to their Chinese joint venture partners. There are apparently 28 pages in the deal on intellectual property matters alone.
- Expectations are that, should a deal be struck, the U.S. and China would likely roll back their third round of bilateral tariffs (on $200B of goods at a 10% rate). If true, this would represent a significant unwinding of tariffs, although the other tariffs would remain in place.
- However, keep in mind that non-tariff frictions are likely to persist between the two countries in the short term, such as by targeting individual companies. The U.S. and China are also likely to continue butting heads in the long run over issues such as the role of China’s state-owned enterprises. Even as U.S.-China tariffs plausibly shrink, there could be an offsetting expansion of auto tariffs elsewhere.
- China stimulus:
- China has been delivering a mix of monetary and fiscal stimulus for some time in an effort to stabilize growth.
- The fiscal stimulus, in particular, is hard to quantify. This is in part because announcements are continuing to dribble out. It is also in part because the type of stimulus is unfamiliar – tilted toward tax cuts as opposed to infrastructure – and it is hard to quantify the exact size of the stimulus.
- To illustrate the last point, China is officially targeting a fiscal deficit of 2.8% of GDP in 2019. That’s up slightly from 2.6% in 2018. This suggests a mere 0.2ppt of fiscal stimulus.
- However, the analysis is not quite as simple as this. Off balance sheet borrowing (such as via local government financing vehicles) can create a very different picture. Indeed, some pundits are looking for as much as a 2ppt fiscal boost, plus a further lift from monetary stimulus.
- If correct, this latter analysis makes a much stronger case for Chinese growth to cease its deceleration into the second half of the year.
- Chinese data:
- China recorded two notably positive data points recently. This was a welcome change for a country that has mostly suffered through negative trends for the past six months.
- One positive figure was the Caixin China Manufacturing PMI, which staged an unexpected and substantial rebound.
- The second positive reading was China’s aggregate financing figure, which raced to a record 4.6 trillion RMB in January.
- However, we are still unconvinced that the Chinese economy is truly bottoming. The credit figures may be partly distorted by the Chinese New Year, and other Chinese PMI figures do not corroborate the Caixin Manufacturing measure.
- China’s growth target:
- Reflecting the structural element of China’s slowing economy, Chinese policymakers have now set out a diminished growth target for the coming year.
- Despite all of the aforementioned fiscal stimulus, China is now aiming for just 6.0% to 6.5% growth over the next year. That’s down from its 6.5% target for the prior year (and targets for previous years that ran even higher than that).
- Our forecast is for the low end of this range – 6.0% growth in 2019. This reflects the combination of a slowing global economy, diminished Chinese competitiveness, poor Chinese demographics, slowing globalization, the lagged effect of tariffs and domestic deleveraging efforts.
- In short, China’s latest stimulus efforts should not be discounted altogether. They could even be larger than officially reported, but there are plenty of headwinds jostling in the opposite direction.
Some positive data points:
- Amid a broadly decelerating economic environment, we are always on watch for any evidence of stabilization. While hardly overwhelming in number, there were several recent data points that presented a more positive story.
- As mentioned in the section above, China recorded improved figures for select PMI and credit readings.
- Also, in the EM space, India’s manufacturing PMI continues to rise.
- The latest S. Beige Book report – an anecdotal take on business conditions – reveals that 10 of 12 regions reported slight to moderate growth in the latest survey period, up from just eight over the period before that. Both the manufacturing and services sector were reported to have strengthened. That said, several details also acknowledge the challenges associated with the lateness of the business cycle: the rate-sensitive housing market is now sputtering, worker shortages are notable, wages are rising and margin pressures are being felt.
- We put a heavy weight on the direction in which the consensus global growth forecast is trending. The 2019 forecast remains on a downward trajectory – a familiar story, and one that supports our below-consensus growth forecasts. But beyond that, the 2020 consensus forecast recently edged slightly higher. This merits close watching. So far, it is just a single monthly increase and the gain was minuscule (merely 0.004% higher). Furthermore, the flagship OECD just downgraded its own global growth forecast for both 2019 and 2020 this week. Thus, while this fascinating new direction in the consensus could be a signal, it might only be noise. Time will tell.
Other interesting items:
- Canadian Q4 GDP: Canadian GDP laid an egg in Q4, growing by just 0.4% annualized. This is the worst performance since the Fort McMurray fires in Q2 2016. A big part of the latest weakness was also oil-patch related, with oil & gas extraction down by around 8%, as calculated by RBC Economics.
- But even without that concentrated drag, GDP growth would have been merely +1.0%. That’s still well short of the recent norm. The Canadian slowdown is not a huge surprise to us. This is in part because of our long-standing bearish stance on the country due to evident challenges relating to oil, housing and competitiveness. But it’s also unsurprising in part because our own leading indicator long ago turned lower, presaging this release.
- On a monthly basis, Canadian GDP has now shrunk in three of the past four months. Growth is more likely than a further decline from here, particularly as the sharpest part of the oil decline is over. But we continue to budget for below-consensus, underwhelming economic growth.
- Bank of Canada: The BoC was dovish in its latest rate decision. It acknowledged the recent run of bad data and the prospect of poor growth over the next few quarters. The BoC also dropped its reference to the need for the policy rate to rise to a neutral setting over time. The market reacted to this news by reducing the probability of a Canadian rate hike by July from 18% to 0%, and increasing the probability of a rate cut from 2% to 21%.
- ECB: The European Central Bank also jumped on the dovish bandwagon. It was motivated by two main factors:
- a growth target that was slashed from 1.7% to 1.1% for 2019 (we are at 1.25%), and
- an updated projection that inflation will hit just 1.6% in 2021 (meaning it will still be short of the ECB’s target in three years).
In response, the ECB has now committed to not hiking rates for the entirety of 2019. It had previously made this promise merely with regard to the first half of the year.
Similarly, the ECB has now introduced a program that will begin delivering liquidity injections into the European banking sector beginning this fall. More broadly, the ECB is in the difficult position of never having lifted its policy rate off of the floor and never having shrunk its balance sheet. This will make any future downturn quite hard to manage.