China: Slower Economy, Weaker Currency

Published on October 11, 2018

By this week, nine economic departments will have formally submitted their respective forecasts for the major economic data to China’s Central Financial and Economic Affairs Commission and State Council, all of which is then analyzed at a meeting chaired personally by Premier Li Keqiang. The final results will then be released by the National Bureau of Statistics on Friday, October 19, at 10:00 a.m., local time, accompanied by a press conference.

The Q3 data, we understand, may mark a modest slowdown even in the official numbers to 6.6% year on year for Q3 (from 6.7% – the lowest in two years), and 6.7% cumulatively for the first nine months of the year (from 6.8%). We expect officials to point to evidence of stability in other underlying data, including industrial output, retail sales, and a historically low urban unemployment rate that has registered an impressively low 5% for September when calculated across 31 major cities.

*** But of greater interest than a rounding error in what may already be a largely well understood modest slowdown of the Chinese economy is the growing concern and discussion we have picked up in senior policy making circles over the growth outlook for the first half of 2019. As things stand, Chinese officials expect growth to continue to slow down to a 6.4% – 6.5% pace for the first half of next year. ***

*** While that degree of a slowdown may seem to the casual observer like no great cause for concern, officials are bracing for what they consider will be “the most difficult period” in recent years for their economy. In no small part that sense of difficultly stems from concern that President Trump will press ahead at the turn of the year in imposing tariffs on the remaining, entire stock of China’s exports to the United States. In anticipation of that, sources very pointedly indicate that “once GDP falls below 6.5%, Beijing will adopt a different monetary policy than the Fed or ECB, including lowering interest rates.” ***

*** As things stand, the PBoC, from what we understand, may be already considering another 100 basis points cut in the Reserve Requirement Ratio sometime around late November or early December, that would follow the 100 bp cut just announced. And as to the currency, we would go so far as to say the central government intends to actively guide the Renminbi lower — the “proper G-20 way” of course — through easier money, and by riding interest rate differentials. ***

On FX, Treasuries, and Slush Funds

Officials in Beijing will without a doubt continue to forcefully reiterate that the RMB is market driven (ok, sort of), determined by supply and demand (and maybe some regulations here and there), and that it will not be used as a tool for trade retaliation against the United States (at least not openly).

Having said that, one of the explicit benefits of additional stimulus in the current global cycle will be to manage the currency lower, and “allow” these very market forces to drive the RMB down. After successfully having stabilized the RMB for two months now within a 6.8000 -6.9000 range (see SGH 8/10/18, “China: The Falling Yuan and Stock Market”), we now expect the 7.000 USD/CNY level to give way in short order.

Perhaps one might reasonably expect that to occur after the release of the semi-annual US Treasury FX manipulation report scheduled for next week. While tensions remain high between the two countries, deliberate provocation may not exactly be the most judicious course of action at this time. Then again, maybe not.

On that front, the suggestion of using bond sales to hit the US where it hurts if the trade – and geopolitical – wars keep escalating remains very much alive.

To recap, two weeks ago we learned of a very serious and credible suggestion by a high ranking economic official to Premier Li Keqiang and Vice Premier Liu He that China consider selling $100 Billion of US Treasuries over a two-month period as a nuclear messaging/retaliatory option, to be triggered under the threat of total tariffs from the US (see SGH 9/25/18, “China: New Avenues for Retaliation against the US”).

That, of course, could in turn trigger no small degree of volatility in markets – but it is hard not to note that the Chinese equity markets have been crushed by the trade wars already, and, domestically at least, are roughly 80% still dominated by retail players.

In addition, we have been asked about the impact of US Treasury sales and its potential inconsistency with a currency policy desire to keep the Chinese Yuan weak.

But there again, to add here a touch of our own conjecture, by the beginning of next year the CNY could very well already be trading at a substantially weaker level than 7.000 to the US Dollar. Furthermore, a reallocation of the proceeds from US securities sales into, for example, European bonds is entirely consistent with President Xi Jinping’s longer term strategic reserve re-balancing objectives as well.

On a final miscellaneous, but key point, for further stimulus the leadership in Beijing is also eyeing the possibility of tapping the secretive “Premier’s Fund,” set up initially with about 200 billion CNY. That fund, from what we understand, has now ballooned to about 1.3 trillion CNY.

Games without Frontiers

All that does not even begin to address the tensions that have been rising between the two countries beyond trade. For a Chinese perspective, a source suggested to us last week that Sino-US policy may now be following a template uncomfortably reminiscent of the US-Soviet rivalry that broke up the USSR as a military as well as economic competitor to the US, and the US-Japan tensions that led to a surge in the yen and at least temporary collapse of Japan’s threatening export industry, followed by a lost decade or two.

Of course that is one narrative. But following on the heels of a series of provocative naval incidents between the US and China, the sanctioning of a senior Chinese defense department official, the arrest and extradition yesterday of a Chinese agent from Belgium, and the unmitigatedly hawkish speech by Vice President Mike Pence on US-China relations, sources in Beijing are now fully braced for US military exercises or some other deliberate provocation in the South China Sea and Taiwan Strait around the first week of November.

That, of course, would be just before the US Congressional mid-term elections on November 6.

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