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31 Jan 2024 | 5 minutes to read
With Chinese growth still a concern for investors, Chinese equities have been weak. Last week brought news of further policy easing but will it be enough to support the economy? China faces the prospect of lackluster growth this year, as weak external demand, a troubled real estate sector and a moribund consumer weigh on activity. GDP is expected to grow by around 4.5% in real terms this year, compared to 5.2% in 2023, and above 6% in the years prior to the pandemic. This soft demand picture is resulting in disinflation, with CPI below 0% for much of the last 18 months. Coupled with a significant debt burden, this poses a risk to the economy.
Beijing is clearly alert to the issues impacting the economy, but faces the challenge of supporting growth without undermining efforts to rein in financial risks from local government and property sector debt, creating new instability in the financial sector. The result has been a gradual easing of fiscal, monetary and regulatory policies, rather than a 2015-style big bazooka response.
Beijing’s efforts continued last week, with the People’s Bank of China (PBoC) announcing a further 0.5% point cut to the Reserve Requirement Ratio (RRR), the rule governing how much banks must hold as reserve. Lending and discount rates for small businesses and agricultural firms were also cut by 0.25% points. The RRR cut is expected to release c. RMB1trn of capital into the financial system, without endangering bank stability by attacking the Net Interest Margin of banks.
The PBoC’s Governor also revealed that Beijing will soon relax restrictions on operating property loans for property developers, offering further incremental support to the real estate sector. This is likely complicated by a Hong Kong court’s decision to order the liquidation of Evergrande, the world’s most indebted real estate developer with liabilities in excess of $300bn. The majority of Evergrand’s assets are in China where Kong Kong has no jurisprudence.
More controversially, Beijing is reportedly seeking to support the equity market via a “stabilisation fund”, financed from the “offshore accounts” of state-owned enterprises.
While we expect further easing announcements this year, growth is likely to remain weak unless Beijing addresses consumer confidence head-on by strengthening China’s social support.
Following the shift in December, markets are confidently pricing in rate cuts across developed market regions in 2024. This includes Europe, where the probability of rate cuts increased in sympathy with the move in US pricing, following the last FOMC meeting. However, in contrast to US Federal Reserve Chair Powell’s acknowledgement that the timing of cuts was “the next question”, ECB President Lagarde had been pushing back against growing expectations of rate-cuts. The expectation was that this resistance would continue at last week’s ECB meeting.
As expected, the Governing Council voted to leave rates unchanged but opposition to rate cuts was notably less than in December. In the press conference, President Lagarde reiterated that it was premature to discuss rate cuts now and that the ECB’s future policy decisions would be data-dependent. Lagarde also gave an update on the ECB’s review of its toolkit, commenting that work is advancing at a fast pace and would most likely be done by the end of spring.
Futures markets are currently pricing in over five 0.25% rate cuts this year in the Eurozone, starting in April. While Eurozone growth is currently weak, the economy is not collapsing and is expected to strengthen from the second quarter. Against this backdrop, the Governing Council would likely prefer to wait as long as possible to deliver cuts in the Eurozone, given that it is always possible to cut by more than 0.25%, and an early move on rate cuts will likely stoke the expectation of further cuts. However, much will depend on the timing of cuts in the US, where the first cut is pricing in for May.
Given the importance of US rate expectations for the global market, how is US economic data evolving and does it support the case for a cut in May? GDP growth data, released last week, revealed stronger-than-expected activity in the fourth quarter, with growth of 3.3% quarter-on-quarter annualized. This was ahead of consensus (at 2%) but slower than from the 4.9% rate delivered in the third quarter.
Should this strong GDP print worry market participants? Continued resilience across consumption reiterates the fact that the US economy is far from collapse, making the case for patience in cutting rates. However, net trade and inventories were the main drivers of the stronger-than-expected print, and these elements are volatile, with inventories likely to kick into reverse in the first quarter.
Indeed, US growth is expected to slow in the first quarter, a step that could embolden policymakers to ease rates. In the meantime, we continue to keep a close eye on employment data, especially Friday’s non-farm payroll report.
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