What happens when you start tightening liquidity after pumping it in to help out certain sectors of the economy? The answer may surprise you. It probably won’t though because it’s pretty obvious.
China is currently doing exactly that — tightening liquidity, per the FT — to prioritise “financial security”. The rough narrative is that China is looking to avoid any financial shocks that would undermine president Xi in the run-up to the leadership transition late this year.
It’s always a gamble guessing how long any credit slowdown will be allowed to last but according to HSBC its’ “the strongest financing deleveraging measures since the cash crunch that rattled the market in 2013”:
The strong rebound in growth in 1Q17 has provided Beijing with a welcome opportunity to tackle the issue of financial deleveraging. This had led to a rise in onshore rates – up c35bp in April alone – even though US rates have been edging down. Like Chinese corporates, the country’s financial institutions have rapidly expanded their balance sheets over the last few years; their assets now total RMB232trn vs their US counterparts’ RMB110trn. At the same time, more transactions are taking place within the financial system rather than in the real economy, significantly reducing credit efficiency while increasing financial market risks. In response, regulators are enforcing the strongest financing deleveraging measures since the cash crunch that rattled the market in 2013, causing a decline in the stock and bond markets.
The deleveraging efforts rely on the economy’s improved ability to endure higher borrowing costs. As the rebound loses steam, we think credit stress and defaults will begin to rise. The fall in the stock and bond markets is also complicating companies’ refinancing efforts. While the regulators want to press on while they have the chance, if they tap the brakes too hard they will come under pressure to ease off in order to protect economic growth. The key question for the regulators and the market is no longer whether China has a credit problem. Rather, it is how China can fix the problem and what price is it prepared to pay?
Here’s a chart from Barclays to underline that move and the ongoing bond shakeout:
That tightening — however long it lasts — is going to start reversing the credit-fuelled surge in infrastructure and real estate investment that boosted the old economy and GDP growth while also building up imbalances which would eventually have to be worked out. The losers in this should be pretty obvious. They’re the ones that gained. From self-confessed China bulls, Bernstein’s Michael Parker and Kelman Li, with our emphasis:
Over the last month, three proxies for Chinese credit-intensive growth – concrete, real estate and autos – have begun to reflect the inevitable: the rapid acceleration in credit growth that began at the end of 2015 has to end. Great Wall is down 10% in the last 30 days (and up almost 50% over the last 12 months); CNBM (a large concrete producer) is down 14% since mid-April (and up ~30% over the last year). Sunac, a Chinese property developer, has doubled since this time last year and is down 11% in the last month. The Chinese gaming sector is getting hit too. For reference, the MSCI China is up ~3% in the last month.
Commodities are taking a leg down as well. Oil is down -9% in the last month, coal -12%, iron ore -19%, copper -5%.
And, more broadly:
The key metric for us is simply total social financing growth. Total social financing growth and fixed asset investment growth decelerated between the end of 2012 and the end of 2015. The acceleration credit formation growth accelerated in 2016 created the commodity-, energy- and construction-related rally last year. As that credit formation growth slows over the rest of this year and into next year, we believe expectations of just how healthy the industrial part of the Chinese economy can be while in the second half of a decade long transition of the entire economy to services will moderate. It’s good news, but not unambiguous good news. The losers go back to being losers.
At the end of this deviation from the long-term structural trend, the Chinese economy is still transitioning to services. The longterm strategy of slowing fixed asset investment growth, slowing credit formation growth, talking down growth expectations, talking up the services sector and hoping that the hard infrastructure built over the last 15 years will support the services sector and the consumer is – we believe – all still in place. For the last two years, an easy credit environment has, as a short-term and episodic measure, been implemented to address the weak industrial economy. But the industrial economy is no longer weak. And the transition to services continues.
That is all terrific news for the global economy and for Asian and Chinese equities. The near-term macro risk is off the table. The world’s second largest economy looks to be in pretty decent shape both in terms of industrial and consumer activity. The mechanics of fiscal and monetary policy in China still work. The capital flight risk has faded. But it is terrible news for the M1- centric parts of the economy.
What goes up etc…
Related links:
China growth headed lower as commodity rout hits factories — FT
China yield curve inverted as regulators target leverage risk — FT
