Where did China go?
Positive signals from China despite the gloom, says chief analyst Bo Bejstrup Christensen.
I have been working with global investment strategy for more than ten years, covering China for close to seven of those years. Yet I am still surprised – also in relation to recent events – about how quickly the financial markets can shift their focus. During the first few days of the year, China’s currency, the yuan, (which was unexpectedly devalued) was the centre of attention, but market focus quickly shifted to the negative fallout from low oil prices, to a potential US recession and, most recently, to the health of European banks. China has almost disappeared from the debate, but perhaps it is time to revisit China – and its much discussed currency.
China’s New Year slumber
One reason why market attention turned away from China is simply that China, from a financial markets perspective, sank into a New Year slumber. China’s New Year holiday has just ended, but for a week or so China switches off. Millions of people return home to celebrate the New Year with their families, including the many migrant workers who normally man the country’s factories and assembly lines. A complicating factor, however, is that the New Year holiday is somewhat fluid, so seasonally adjusting data from January and February is notoriously difficult. This caused considerable uncertainty some years ago when the market focused on one particular weak figure for January, which was later offset by a strong figure for February. In recent years, the authorities have, sensibly, declined to release much of the data for each month and instead publish the collated data for both months in March. Hence, one reason China has faded from the front pages is simply that the Chinese markets have been in a vacuum. We are getting very few numbers to consider, and at the moment no news is almost good news.
Currency stable – and will remain so
However, the main reason for the relative silence on China is, in our opinion, that the currency debacle in the opening days of the year was a mistake. As markets erupted, the authorities quickly returned to the good old regime of maintaining currency stability against the US dollar – and the yuan barely moved against the greenback from 11 January to 12 February. In recent days, the currency has in fact moved considerably higher, leaving USD/CNY at close to unchanged for the year to date.
While the yuan is still a little weak against the broad currency basket index (CFETS RMB Index) the Chinese unveiled last year, the real crux of the problem is that the markets have been unable to figure out just what the Chinese were up to with their currency. This has now been partially clarified. The governor of the Chinese central bank (PBOC), Zhou Xiaochuan, held a rare, long and detailed press conference last weekend, answering questions from the Chinese press and attempting to explain what the central bank aimed to achieve.
Three strong messages
We noted three main messages from the central bank chief:
First, the central bank did not want to cause unnecessary uncertainty. This means the central bank will act to stabilise the currency when market jitters are overdone – like now. And as we have mentioned many times before, with an annual trade surplus of 600 billion dollars, currency reserves topping 3000 billion dollars and limited foreign debt, China has the tools needed to keep its currency stable for a very long time, if and when it wants to.
Second, he pointed to the huge trade surplus as a sign that the currency was not fundamentally overvalued. Put another way, China is still capturing market share at a global level, which does not support the idea of overvaluation. He therefore concluded that, leaving aside speculative attacks and short-term capital movements out of the country, there was no real need to devalue the currency.
Finally, he explained that China still wanted a more freely floating and market-fixed currency in the longer term. Reading between the lines, however, this process will clearly be on China’s terms.
Why China will not devalue
We can therefore conclude that China does not want to be the source of disaster scenarios or uncertainty, and that the long journey towards a more flexible currency is intact. We expect the currency to remain stable in the short term, while in the longer term the speed with which the yuan depreciates against the dollar will mainly be determined by how quickly and how far the US central bank hikes interest rates.
Hence, our view is unchanged – China will not devalue its currency, as there is no fundamental need to do so and, furthermore, it would be the worst possible signal to send. If they did, the market would simply try even harder to push the currency further down.
However, the good news does not stop here. We have been warning since the end of 2015 that growth in China would weaken in the first few months of the year – and while we stick to our story of structurally weaker growth in the long term, a milder wind may blow in the short term.
A stable China is good for global equities
Our short-term take on the Chinese growth cycle is very much based on the housing market and credit granting. With regard to the former, China has in recent weeks moved to ease its restrictive housing market policy in a couple of areas. For example, the down-payment required from first-time buyers has been reduced to 20% from 30% previously. We expect this will be sufficient to stabilise housing market activity between now and the summer.
Credit-granting, meanwhile, appears to have increased. This is not an unconditional positive, and in the long term we would still urge caution on China and the emerging markets generally, but in the short term at least, the authorities’ focus on supporting growth will likely succeed.
Despite the scepticism and confusion currently prevailing on China, our view is that China will become a source of stability in the spring, which is good news for global equities – especially given the many doomsday prophecies of a currency collapse, financial crises and full-blown recession. Hence, yet another reason to maintain our positive stance on equities.