FX Daily: China’s Sneaky Stimulus

4th June 2014

  • German Chancellor Merkel has asked France’s Hollande as to whether they would support the nomination of IMF head Lagarde as the next EC President, a nomination supported by the UK. (The Telegraph)
  • RBS has become the second bank to cap large mortgage loans- particularly in London- over fears the property market is overheating. (The FT)
  • ECB officials are expressing concern over the extent of fines being levied on European banks by US regulators and are considering adding a further element to cover the fines in the AQR tests. (WSJ)
  • China’s Export-Import Bank has plans for a sharp increase in lending to Greek Shipowners to assist in financing of new ship orders in Chinese ship yards. (WSJ)
  • Investors used the recent sell-off in Japanese equities to buy companies that will benefit in a rising inflation environment. (WSJ)
  • China will introduce its first bond used to fund corporate mergers and acquisitions. The bond, worth of CNY1 billion, will be privately placed in the interbank market and underwritten by Citic Securities, with the proceeds to fund an acquisition between two mining companies. (Economics Information Daily)
  • The frustration for Japanese politicians and investors over the much anticipated reallocation of the GPIF’s massive investment portfolio is set to continue. Tuesday’s release of the health ministry’s report was eagerly awaited by investors, as it was believed to give more insight on the GPIF investment plans, likely formally announced in July. (WSJ)
  • Fed’s George said Tuesday that the Fed should begin some “passive” shrinkage of the Fed’s bloated balance sheet before it starts raising interest rates, staking out a different position then some of her Fed colleagues. (MNI Market News)
  • Fed officials are becoming nervous over the current tranquillity in financial markets, as volatility remains at record lows. Fed uber hawk Fisher warned again Tuesday on market complacency over “low rates for ever”. (WSJ)
  • UK’s Shop Price Index fell a further -1.4% on the year in May, undershooting expectations for -1.3%.
  • Australian GDP expanded 1.1% on the quarter in Q1, beating estimates for 0.9% growth and Q4’s reading of 0.8%.

The Australian dollar jumped higher to just below the $0.93 level this morning on the back of a strong first quarter GDP read. Sellers emerged off this level, leaving the cross to consolidate in the $0.9280 region. A stronger dollar then acted against the rate to leave it at the level at which it had all began – $0.9260. Australia recorded 1.1% quarterly growth in the first three months of the year, corresponding to 3.5% annualised growth, something other G10 economies could only dream of. Exports contributed 1.1% to quarterly growth, the single biggest drive of output gains while investments contributed zero and public expenditure a mere 0.1%. Of the 1.1% added by exports, 0.9% was mining exports, revealing an extremely weak backdrop if we extract for a sector that is publicly recognised as on a declining trend. Tuesday’s trade data again showed that higher commodity export volumes but lower values as commodity price declines bite. Australia faces several hurdles down the road, reinventing itself after a peaked mining investment boom, a waning housing market boom, an austerity budget and its consequences for consumption. And that is all without mentioning the risks of a Chinese slowdown. We still maintain a short-term buy Aussie recommendation, on the fact that we are in a carry trade environment and this is triple A carry.  However in the medium to long-term we believe the Aussie’s direction is lower especially if Chinese policymakers have a change of heart and once again decide that reform and slower growth are preferable to rapid debt backed growth.

Chinese Premier Li concerned global investors when he talked of a “new normal” for China, meaning stable, subdued growth rates, while the economy tackles the underlying problems of overcapacity and burgeoning debt. Despite these big words, from early April Chinese policymakers began to announce, with little fanfare, easing measures. A “mini-stimulus” package extended large tax breaks to SME’s and pledged to build social housing and accelerate construction of rail lines, with an immediate injection of CNY100bn. However there was more stimulus to come, reserve requirement ratio cuts for rural banks, instructing banks to accelerate mortgage lending to households, increase its re-lending facility with CNY400bn directly to infrastructure projects and CNY50bn for SMEs and instructing local governments to front-load payments and accelerate spending plans. This sneaky stimulus may be directed at specific sectors of the economy but it has the same overall effect of broad monetary easing and carries with it the same risks. Chinese authorities are constantly fighting an internal battle of the need for reform and the reality of the slower growth it brings. China is always making grand public commitments to reform its economy but seems to shy away when it sees the consequences of slower growth and capital outflow. However Chinese officials aren’t simply slaves to superficial growth rates. Their real concern is creating employment for the millions of Chinese coming into the labour force and the consequence of serve social unrest if the economy cannot keep pace with its population growth. China is unlikely to let growth drop below 7% for too long and is likely to repeat this cycle of commitment to reform and then backtracking with stimulus programme. Like all cycles, this will eventually have to come to a climax, and given the rapid growth of debt, overcapacity and bubbling housing market we doubt it will be a happy ending.

Eurozone CPI printed at just 0.5% in May yesterday effectively sealing the deal for ECB easing on Thursday. More telling than the figure itself was the reaction to it, as markets immediately took profits on bets that CPI would undershoot and ECB action would be a shoe-in. In fact, the Euro actually rose higher after the inflation data, regaining a handle on the $1.36 level and continuing to lock in gains throughout the European session, before settling around $1.3630. Yesterday’s price action was a litmus test of how markets are positioned ahead of Thursday’s key decision and it suggests markets are dangerously positioned to profit take on any ECB announcement. The ECB is almost set up to fail and it will take an arsenal of monetary policy weapons to achieve Draghi’s ultimate aim: for the Euro to actually weaken following the announcement. The ECB faces a lose-lose situation going into Thursday’s policy meeting and the Council will have to pull off another ‘OMT Magic Moment’ if they are to achieve their aim of a weaker Euro. We believe higher euro levels are achievable against most currencies in the aftermath of the meeting and advise euro buyers to take advantage of three month lows in the currency now.