Recent policy moves in China have left investors wondering if larger-scale stimulus is on the way to lift global growth. We don’t think so.

Our Top Market Takeaways for the week ending December 13, 2019.

It was quiet…until it wasn’t

Markets were muted for the first half of the week as investors awaited a flurry of news on trade, monetary policy and politics. But by Thursday afternoon, the S&P 500 had rallied to hit its 27th all-time high this year, and the MSCI All-Country World Index (an index of both developed and emerging market stocks) notched its first record since January 2018. What changed? Here’s our top three market-movers for the week.

  • The late-week good feels were in large thanks to (you guessed it) trade. News came last night that the United States and China shook hands on a long-awaited “phase one” trade deal, just days before another tranche of U.S. tariffs was set to kick in on another $160 billion of Chinese goods. Caveating that the finer details on the deal are scarce, both President Trump and Chinese officials confirmed this morning that the recent progress means this weekend’s scheduled tariffs will be kept at bay, while other goods will likely see a reduction in currently imposed tariff rates. The deal (once it’s signed) is also said to tackle issues on food and agricultural goods, currency matters, technology transfer, intellectual property, transparency, and dispute settlement. This news of de-escalation is certainly welcome, but just remember that the deal isn’t signed yet, and markets will likely continue to swing on both good and bad news.
  • In other news, is the Brexit saga (finally) coming to an end? U.K. voters hit the polls yesterday, and PM Boris Johnson’s Conservative Party won a majority of seats. Sterling popped to $1.34 versus the U.S. dollar—its highest level since June 2018, and the United Kingdom’s FTSE 250 rose to a record high amid the news. Johnson will likely bring his Withdrawal Agreement Bill back to Parliament before Christmas, making it all the more likely that the United Kingdom will leave the European Union by January 31, 2020. From there, the fun of negotiating the United Kingdom’s “transition period” begins.
  • We also had our last FedTalk of the year. At its December meeting, the Fed kept interest rates unchanged, following three rate cuts earlier this year. Continuing its “data dependent” approach, Fed policymakers signaled rates will stay right where they are through 2020—an encouraging sign that interest rates won’t become too punitive anytime soon. But while the Fed may be on hold for now, other central banks, namely China’s, are still on the move. So with all this good news, why don’t we expect a reacceleration in growth from here?

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Is China really stimulating its economy? Not really.

China has ramped up rate cuts over the last few months, and these piecemeal moves have left investors wondering if larger-scale stimulus is on the way to lift global growth à la 2015 (or 2012, or 2009). But spoiler alert: We don’t think China has launched any meaningful stimulus, and we don’t think it’s coming in the near future.

To understand why recent rate cuts aren’t really “stimulating” the economy, let’s take a look at how the People’s Bank of China (PBOC) works.

What can the central bank do in China?

The PBOC has been rapidly adjusting its toolkit to look more like other central banks. In the last few years, it’s moved from a crude set of fixed lending and deposit rates to a number of instruments that allow it to better calibrate domestic interest rates. The PBOC can influence the economy in two ways—by setting interest rates (like other central banks) and by actually controlling how much borrowing flows into the economy (this is special).

Try thinking about it in terms of price and quantity. We all know that central banks set the price of credit—lower interest rates make the cost of credit cheaper to help stimulate the economy, while higher rates raise the cost of credit to slow things down when there’s a risk of growth overheating. But thanks to the fact that China’s largest financial institutions are mostly state-owned (and thus under direct control), the PBOC can control how much credit that banks can provide (the quantity), and thus give direction on who gets more credit. In other words, the PBOC can direct more lending when it wants to stimulate, and restrict lending when it wants to tighten.

Got it… So what are the implications of the recent rate cuts?

We see the recent cuts serving two goals: 1) maintaining stable money supply, and 2) moderately lowering the cost of debt.

The first goal is one of most central banks’ basic functions. On the second, China is faced with a tough debt situation. Many businesses are highly leveraged, and lenders (i.e., banks, debt instrument investors) bear high credit risks. Under pressure from sluggish global growth and the trade war, businesses are making less profit, which makes it harder to service their debt. In addition, data shows that the actual cost of credit has remained elevated during the past two years, despite the PBOC’s various rate cuts here and there. Therefore, the recent moves look intended to make the cost of debt more manageable for businesses and prevent a debt crisis.

Line graph shows the weighted average lending rate from 2009 through September 30, 2019. It shows that since 2016, despite number rate cuts, credit costs have risen.
To avoid unleashing more credit that could further exacerbate debt stress and create asset price bubbles, China has also employed quota controls and crackdowns on shadow banking. As a result, total credit growth since 2018 hasn’t grown, and it’s actually the lowest since the financial crisis. From this lens, recent moves can’t really be regarded as “stimulus.”

Line graph shows the 6-month trailing average of the net new credit/GDP. The gray bar chart shows the net new credit/ GDP. Both show data from 2006 through October 31, 2019.

What’s all the hubbub about Chinese stimulus?

China is the world’s second-largest economy, and it’s experiencing significant cyclical weakness. Historically, this hasn’t been good news for global growth. Tax revenues (a good proxy for overall economic activity) and industrial profits growth are both contracting. Import growth is deeply negative, and industrial production (roughly 40% of GDP) growth has slowed sharply. This kind of weakness was only seen in the global financial crisis and the housing recession in 2015. Naturally, the central bank is expected to stimulate growth.

We don’t see much space for the PBOC to launch any meaningful stimulus in the near future.

Unfortunately, this is not something China can do at the moment. Why? First off, those high debt levels we mentioned. Secondly, high inflation due to the outbreak of African swine fever has pushed up pork prices. Finally, policymakers have learned the lesson that liquidity injections are more likely to pour into the housing market instead of helping businesses (and with property prices already very unaffordable, they don’t want to take the risk). For any nerds like us who like to read Chinese policymaker speeches, they have been exceedingly clear that we should not expect a flood of credit like that seen in the past. Therefore, we don’t see much space for the PBOC to launch any meaningful stimulus in the near future. But we do think the policies can help reduce debt costs and stabilize growth.

Person of the Year

If you don’t know her already, meet Greta Thunberg, TIME’s 2019 Person of the Year. The 16-year-old Swede has been making major waves over the last year for her activism on climate change. And it all started with skipping school: Back in August 2018, Thunberg spent days in front of Sweden’s Parliament with a simple sign reading, “School Strike for Climate.” Since then, Thunberg has traveled the world to give impassioned speech after speech to world leaders—a list that includes the heads of state at the United Nations, CEOs at Davos, and the Pope. Her efforts have likewise catalyzed similar efforts by her peers across the globe, with hundreds of thousands of teenagers leading #FridaysForFuture climate strikes. She was even nominated as a candidate for the Nobel Peace Prize earlier this year. Thunberg’s accolade as TIME’s Person of the Year isn’t just special because she’s the youngest person ever to receive the designation, but also because it reflects the mobilization of a cause greater than herself. Along with her efforts, 2019 could well be an inflection point for global attention to climate change.

Swedish climate activist Greta Thunberg is pictured after disembarking from the catamaran La Vagabonde at the Santo Amaro docks in Lisbon, on December 3, 2019.

 

All market and economic data as of December 2019 and sourced from Bloomberg and FactSet unless otherwise stated.

We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.

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