But with the yuan under heavy pressure from market forces and key growth metrics heading towards a crisis point, the government’s intervention suggests Chinese participation could look very different in H2. Halting the fall of the yuan looks to be key to the government’s policy shift.

This morning’s (Monday) numbers shine a light on the predicament. As Deutsche Bank’s research points out, it’s a mixed bag. GDP, up 6.3% from Q2 a year ago, fell short of +7.3% expectations, and while the 0.8% growth rate over the quarter was slightly up on 0.5% projections it’s a long way off the prior 2.2% quarterly reading.

Retail sales year-on-year also underwhelmed (+3.1% in June versus +3.3% expected and +12.7% in May), although industrial output was up 4.4% versus 2.5% expected. “Post-covid momentum is faltering rapidly” writes DB, and the numbers are “certainly soft enough for the stimulus cries to get louder as we approach the Politburo meeting at the end of the month”.

Given China’s historical influence on tech, commodities, currencies and even US Treasuries, it is surely a moment for credit market professionals to sit up and take notice. China’s seeming absence from forward outlooks on US and European markets does not mean the world’s second largest economy is any less important. In fact it implies a distortion of global metrics that could soon seek realignment, creating opportunity in some segments and a new set of problems for others. Moreover, China will become a much bigger component of US discussion into the 2024 election season.

As old Lao Tzu said in the Tao Te Ching:

Clay is shaped to form a vessel;

What is not there makes the vessel useful

Doors and windows are cut to form a room;

What is not there makes the room useful.

Therefore, take advantage of what is there,

By making use of what is not.

Reading the Xi leaves

Take this section of Macro Prophet with a healthy dose of cynicism, but here’s my reading of what just happened.

PBOC governor Yi Gang is widely tipped to soon step down from his role, but there has been no party statement on this or who is to replace him. Yet the US government has repeatedly referred to Pan Gongsheng, the Chinese Communist Party Committee Secretary, as ‘PBOC head’ or ‘acting governor’.

Yi Gang was involved in Yellen’s protracted meetings, but little detail has come out on what they spoke about. And his name has been absent from subsequent statements.

“I’ve met with premier Li [Qiang], vice-premier He [Lifeng], finance minister Liu [Kun], PBOC head Pan [Gonsheng], and other senior officials to discuss important pillars of our economic relationship,” Yellen told a press briefing.

Pan being named last does not look accidental but he was recently named as the party’s leading official at the PBOC, drawing speculation that he will take on a consolidated role as governor in due course. Asked if this was her understanding, Yellen said she didn’t know and instead mentioned having spoken with the ‘acting governor’.

Pan’s appointment would be consistent with a growing sense that China is looking to centralise its grip on the economy. Yi’s recent statements expressing the futility of fighting markets to defend the yuan would not have sat well with the party given the country’s economic predicament. His removal could suggest it is shifting stance to go to war with those forces as it tries to halt the yuan sell-off.

Pan, for his part, is not a member of the all-important Standing Committee, so his appointment to such a nominally high position would sit at odds with his political stature. But he has made a career of towing the party line, raising the prospect the PBOC could be led by a symbolic figurehead and is to become an order driven machine of government.

Moreover, Pan helped implement the “three red lines” that crushed the Chinese property sector in the first place, as well as being instrumental in the government’s tech crackdown efforts. Both of these are approaches are now being unwound, with Pan in a position to oversee and manage their unwind.

Broken China

Unlike most countries in the world right now struggling against high inflation, China is teetering on verge of disinflation. This is a big change from the start of the year when all the talk was of China having a good year, a conversation skewed by January being its first full month after it removed Covid-19 restrictions.

A big slump in inflation in February took it down to just 1%, having been at a healthy rate of 2.7% in July last year and 2.8% in September. Even lower readings have followed, however, and June’s came out at zero.

This means China has the lowest inflation of any G20 country, with Switzerland the next worse at a comparably whopping 1.7%. The previously disinflationary Japan is back to 3.2%.

The short-lived illusion of recovery came with the realisation that China consumption is still dampened from the massive hit wealthier households have taken from the country’s real estate bubble having burst. Data in that sector is still very poor, while youth unemployment is also a big challenge given a lack of job openings for skilled graduates in tech and edutech.

“While the removal of Covid-related lockdowns and pent-up demand supported GDP growth in the first quarter of this year, economic momentum has moderated, and the property market remains sluggish,” wrote Gordon IP, co-chief investment officer, fixed income at Value Partners, in a note this week.

“In addition, the financial health of local governments has attracted the attention of investors, given the sizeable year-on-year contraction in land sales, which is the biggest revenue source for many local governments. Deflation risks may heighten if economic activities and confidence fail to pick up. The slower growth trajectory has raised the possibility of further policy easing before and during the July Politburo meeting.”

China companies find themselves with the problem of being unable to pass on cost increases or raise staff wages without taking a hit. And, unlike many other countries that have had to sharply hike rates to dampen inflation, China has been on a path of cutting rates since Q3 2019. From 4.35% during that time, the current rate is down to 3.55%. Yet this hasn’t had the desired impact.

China’s Producer Price Index also tells a tale of woe for companies, given it has been in negative territory for nine months and the pace of decline has picked up each month. Compare and contrast a 4.2% positive reading last July to the latest -5.4% calamity in June. This is worse than during the covid-19 pandemic hit it took early 2020.

China PPI, via Moody’s Analytics

Hand in hand with this, the Purchasing Managers Index — an important signal for a country heavily dependent on manufacturing — has been in contraction for eight of the past 12 months. There’s a similar story of disappointment behind these numbers, because the index managed a small amount of growth in January, February and March. But since then has slipped back into contraction.

Which brings us to the crux of the Chinese government’s central bank conundrum: the yuan is falling. In the first part of 2023 there was a bounce back in the yuan with a dollar equalling 6.7 yuan in February. But a persistent bleed out since then places a dollar at 7.24 yuan. This means that, coupled with the lack of demand at home, China as a net exporter is comparably 8% worse off on the earnings its companies make from shipping goods overseas.

Ip expects the policy tone to remain supportive, but more targeted toward consumption. Monetary policies should stay accommodative to maintain a broadly stable liquidity environment.

“Other than the deposit rate cut and LPR cut in June, there could be further RRR [reserve requirement ration] and policy rate cuts,” he added.

Indeed, the PBOC said on Friday it will use policy tools such as the RRR and medium-term lending facility to deal with its challenges.

Ready for a rocket

China is a country desperately in need of moonshot ideas if it is to stimulate the economy and reinvigorate confidence. Previous attempts have focused around construction / projects, and last week the government reiterated the package of support measures for the ailing property sector it first presented in November.

Right now it does not look undeniably on course to fulfil the OECD’s projection of a rebound to 5.4% growth in 2023. And any fall in that growth outlook will impact other countries.

That said, if its current narrative of opening up monetary policy does start to turn the ship — however slowly — that will have an impact on commodity prices. That could be good news for OPEC oil producers that have cut back production in an attempt to push prices back over $80 a barrel, a target with which they have so far found resistance in the mid-70s area.

But it would be another potential worry for US and European central bankers in their battle to bring down inflation. And investors’ recently rejuvenated confidence in a ‘soft landing’ for those economies will not be helped by another big pair of hands grasping for control of the aeroplane.

Of course, more centralised oversight of China’s economic engine does not mean it will be better managed. As such, the biggest risk may be of further disappointment.

“We remain cautious given ongoing challenges on the macro front,” wrote Ip, “including periods of volatility, US recession risks, tightening liquidity, continuing geopolitical concerns, and China’s patchy growth recovery.”

After the rally in Asian US dollar bonds during the first quarter following China’s reopening and policy pivot towards the property sector, sentiment waned due to weakening economic data in China, he added.

“That said, looking beyond the second quarter, we expect Asia’s overall economic recovery to remain on an improving path, given the region’s resilient domestic demand. China’s recovery trajectory should be on track, led by consumption, despite the short-to-medium-term economic uncertainties. Moreover, inflation in Asia continues to ease, which is an encouraging sign and may create room for policy easing in certain markets, such as Korea and India. On the other hand, we remain mindful of various risks, including the global economic slowdown, which could pose headwinds to the region’s export outlook, as well as China’s lagging growth — especially in the property sector — which may take some time to recover.”

Failure to launch

In warning of disappointment, I’m reminded of another famous Chinese sage. I choose to bring it up here because it involves a plan of high ambition, innovative technology and great expectations. Plus I can’t help a certain admiration for the man who tried to undertake it.

Described as the world’s first astronaut, the legendary Wan Hu was supposedly lived any time up to the mid-16th century Ming Dynasty. The crater Wan Hoo on the far side of the moon is named after him. As astronomer Chris Impey writes in his 2015 book "Beyond: Our Future In Space”, Wan Hu had an obsession with getting close to the stars.

“Coming from a rich family, he had a clear path to becoming a high government official, but bureaucracy bored him. Wan Hu was more interested in the Chinese traditions of gunpowder and firecrackers, which had been used for centuries during religious festivals and for entertainment. He also yearned to have a bird's-eye view of the world.”

Impey goes on to describe how, dressed in his finest clothes, Wan Hu sat in a sturdy bamboo chair with 47 rockets attached. He held the strings of two kites to guide him on his flight.

“On his signal, 47 assistants lit the fuses and rushed for cover. According to the legend, a tremendous roar was followed by billowing clouds of smoke. When the smoke cleared, Wan Hu was gone.”

Most interpretations express confidence in what happened to Wan Hu. But I’ll leave it as a mystery.

Source: Marshall Space Flight Center