Written with Zouhoure Bousbih
This week, the Chinese bond market has again been under selling pressure. The yield on 10-year Chinese government bonds once again flirted with the 4%, the highest in 3 years.
The Pboc (the Chinese Central Bank) intervened twice this week by injecting liquidity into the market, for a total amount of 810 billion yuan or USD 122bn , the largest injection since mid-January.
Should we worry?
No. The movement began just after the end of the C.C.P congress (end of October) when the Chinese authorities signaled clearly that they would continue their fight against high leveraged finance, ie shadow banking.
This has resulted in massive sales from Chinese government bondholders notably from mutual funds that are the second largest holders of Chinese state bonds. They feared a tightening of financial conditions.
China’s interest rates have been low so far because of the loose Pboc’s monetary policy. The orientation has not changed but the action of the Chinese monetary policy is now more focused.
The Pboc intervened in the market by injecting liquidity in order to reduce volatility and it will continue to intervene if necessary to correct the excesses of the financial markets.
The Chinese central bank must find an equilibrium between its deleveraging campaign and the stabilization of Chinese financial markets so as not to penalize economic activity.
Does this question the attractiveness of the Chinese bond market for international investors? and the willingness of the Chinese authorities to open their bond market?
At 4%, Chinese government bonds remain attractive compared to their counterparts in developed countries, helped by a stabilized yuan. China’s deleveraging campaign is rather a positive signal sent to international investors. China will not come back on the opening of its bond market to international investors because of the internationalization of the yuan. China’s economic activity remains sound. This is only a moment of turbulence to pass …
Co-authored with Zouhoure Bousbih
The Chinese bond market is becoming more international and opening up to foreign investors. Coinciding with the 20th anniversary of the handover of Hong Kong to China, the Chinese authorities are displaying their aim of shaping world affairs, acting directly on the largest and most important financial market worldwide.
The Chinese bond market is the third largest worldwide after the US and Japan, with assets of $9,000 billion (source FT) if we combine sovereign bonds, agencies and corporates.
Foreign investors only account for 1.5% of this market, which is ridiculously small for an economy the size of China’s. The magnitude of the Chinese economy in the world and the proportionate weighting of its bond market are not yet comparable. But this is set to change, and this shift in balance will mark a lasting transformation compared to the current situation. Continue reading
The Chinese external trade surplus is almost at its highest in August 2015. It is close to USD 60bn. Cumulated on twelve months, the surplus is at its highest ever. That’s what we see on the graph.
Comparing exports and imports’ profiles allows a better understanding of the trade surplus and of the impact China has on the world trade momentum. Continue reading
China has played a major role in all of the stock market fluctuations seen in recent days. However, analysis of this should be discriminating. The Chinese economy has not suddenly collapsed, it is more the Shanghai stock market that has adjusted sharply downwards.
A clear distinction should be made between the two phenomena and we should keep in mind that stock market fluctuations are always excessive relative to economic movements. Paul Samuelson, probably the most influential economist in the post-war period, indicated that the stock markets had forecast nine out of the last five recessions.
The Chinese economy is no longer that which enjoyed growth of 10% a year over two decades. The development of a sizeable middle class has radically changed its growth model. This middle class has other needs than those noted in an economy that is taking off. China is currently in this transition phase. It needs to adapt its economy to more diversified growth with a larger share for services.
This transition is causing and will continue to cause a lower growth rate. If the Chinese economy’s profile follows that of Japan and South Korea, in around 10 years, GDP should therefore grow in range of 3-5% a year. Continue reading
Five points on the current situation
1 – Global level: the expected growth for the world economy is low, no strong drivers in the US, Europe and China. That’s our scenario (we had before the current crisis see my blog here)
The Chinese move on its currency a week ago is a signal that after having done a lot to support their internal market (large SOE indebtedness, stock market bubble) they have tried to improve the situation by depreciating their currency.
It’s a signal that says that the situation is worse than expected
2 – On market the message is: the world economy will have a longer period of low growth without inflation. It means that investors have to rescale their expectations to this trajectory. By itself it’s not a contagion from China to the rest of the world by mechanical means, it’s the fact that growth prospects are persistently lower than thought
3 – Chinese authorities have a role here: they didn’t accept the convergence of the equity market to a kind of fair value after the burst of the bubble. What we’ve learned from 1987 notably is that , in order to reallocate resources, it’s better to let the market to adjust by itself with an accommodative monetary policy
The Chinese authorities have blocked the adjustment by forbidding sales and by imposing investment to brokers. The market is probably still far from its fair value and this will imply further adjustments. This will lead to uncertainty as every Chinese investor will try to exit from the market. (see here)
4 – The good point associated with this situation is the fact that oil price drops dramatically. This will be positive for European economies as consumers’ purchasing power will be boost.
So the impact for western countries will be limited:
a- Because if growth is weak in China, the equity market adjustment is not the sign of a recession
b- Equity markets will adjust downward with volatility in Europe but if the sequence is not too long it will not affect behaviors. It is just if the crisis lasts that we could have an impact on confidence
c- Lower oil price will have a positive impact – The price could go lower (remember 1998 )
5 – This situation will lead to lower interest rates. This is what we currently see with 10Year TBonds at 2% but the probability of a non-action from the Fed at its next meeting (16-17 September) is increasing. The global monetary stance is still accommodative and will remain for an extended period (see here)
The Markit/Caixin index was at 47.1 in August, its lowest level since March 2009. It’s another piece showing that the downturn of the Chinese economy is not over. That’s why I think that the adjustment seen on the Chinese currency is not over.
In the second graph, orders indices are trending downward and do not let expect a rapid U-Turn on economic activity. There is a need for a shock to change the economic profile. A 10% depreciation of the Renminbi is necessary to create a real shock on the economy
Let me show you one chart on Chinese growth. It represents contributions to yearly growth by large sectors. Four points to notice
- The contribution from the manufacturing sector is now very limited. It is no longer the backbone of Chinese growth
- The real estate sector has also a minor contribution.
- The Chinese economy has moved to a model that is driven by services. The growth model has been rebalanced from the industry to services
- The finance sector has a robust contribution. But this latter mainly reflects the bubble seen on the equity market. The strong and deep intervention of the Chinese authorities is expected to limit the market fall after the bubble burst. But we cannot anticipate that the finance contribution will remain at this high level.
With a more limited contribution from the finance sector, GDP growth momentum will converge to a lower path. We can expect slower growth in the future.
In other words, growth has been supported by higher indebtedness since 2009 but it’s no more a source of impulse. A large part of this debt had real estate price as collateral. The real estate price fall since 2014 implies that the current mechanism for debt is no longer operational. With this failure, there was a need for a new instrument to support growth.
This has been the equity market where constraints have been reduced by the Chinese authorities (more relaxed rules on margin trading). The consequence was a large bubble that has burst since mid-June. It will no longer be a support for the GDP growth through the finance sector.
Moreover the will to limit the equity market adjustment is probably wrong. After the 1987 market crash on the U.S. market there was a task force who concluded that it was better to let the market to adjust and to converge to its fair value. It’s a way to limit constraints on investors and to ease and to improve resources allocation. These conclusions were right but the Chinese regulation authority is currently doing the contrary. It will be damaging for growth.
Annex – Chinese debt momentum