Playing Chess with China

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Despite declining import and export growth, recent GDP growth is reported at a 6.7% annual rate. China is attempting to tame excesses and sidestep a “hard landing”.

Markets continue to be roiled by rumors of a trade war between the USA and China, with the global economy growing - though a bit off the boil from Q4 2017. For his part, Chinese leader Xi took the pot off the boil slightly by a conciliatory speech meaning to open their markets a bit. There had been some speculation that China will respond to tariff and Section 301 threats by weakening their currency. This is a tall order: the CNY has appreciated by 11% since December 2016 to CNY 6.31/$. The OECD estimates that the Purchasing Power Parity (PPP) value of the exchange rate is CNY 3.55/$, hence a devaluation would reflect swimming against a strong stream. If – and this remains at the level of talk – the Chinese do try devaluation, a 4% cut probably will not be enough to make a major dent. However, if a sustained devaluation becomes real, capital flows would be affected (think the Asia crisis of the late 1990s), potentially bringing on more capital controls. Chinese short-term rates are about 4%, hence requiring quite a rate cut.

In the high-inflation 1970’s, the concept of ‘bond market vigilantes’ was born where the bond market punished the Fed when its policies were too easy (and vice versa). Over the past few weeks, we have seen the growth of stock market vigilantes, where the market is clearly sensitive to the risk arising from trade wars. Clearly, markets will remain on edge, given that pronouncements from DC are not forecastable, nor are WTO decisions nor actions from China or third parties. Until markets can get some visibility on this issue, measures/counter measures and the like, continue to expect volatility, undergirded by a strengthening global economy and positive market fundamentals.

To see how China’s economy has fared over the past 7 years, please look at page 49 of the Global Perspectives book.

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