New year, new policy?

• Equities edged higher in Europe and the US (+1% in sterling terms)
• Bonds also gained, with gilts up c. +0.5%

• US government bonds faced a mid-week decline, but recovered c. +0.3% by the end of the week

There has been a regular stream of policy announcements from China’s leadership over the last year designed to support growth. However, this has not been enough to support China’s stock market, which has been a poor performer year-to-date.

This lack of enthusiasm can be explained by the gap between what investors are hoping for and what Beijing is likely to deliver. Investors - market signals and experience tells us - are hoping for officials to open the spending taps in much the same way as we saw in 2015. Back then, tighter regulation undermined growth, resulting in a market rout. Policymakers capitulated, committing to sizable infrastructure spending to make up for the developing growth gap. This resulted in a rebound in Chinese growth, and also a boost in demand elsewhere in the global economy.

Why hasn’t Beijing announced something similar this time? Such a policy would run counter to some of the leadership’s current aims including shifting away from investment-led growth and de-risking the housing market. A heavy reliance on capex spending has led to a high debt burden for China, and has not helped drive GDP growth, explaining the current moderation. Instead, there is a focus on improving the financial stability of local governments, with debt swaps, and supporting liquidity for businesses, including property developers with unfinished projects.

Last week, the People’s Bank of China cut the benchmark interest rate for 5-year loans by 25bps, the largest cut on record, which should bring mortgage rates down further. The housing ministry also announced details of a plan to match developers with bank funding, with RMB29bn of funding arranged so far and a total envelope of c. RMB1trn likely (c. $140bn).

Over the weekend, plans were announced for a consumer goods trade-in programme, with government subsidies encouraging households to replace autos and home appliances. The consumer will be key to China’s growth going forward but such a scheme is not big enough to turn around consumer confidence.

We expect further announcements from Beijing, including around the National People’s Congress, but growth is likely to be below 5% without a greater intervention.

Unlike the Bank of England, the US Federal Reserve releases minutes from central bank meetings several weeks after the event. This can be a source of turbulence in markets, as we saw in December when Chair Powell’s dovish tone at the press conference led some to expect a dovish shift in the minutes. When the minutes were released, the even-handed assessment of “many participants” was a surprise, leading to a sell off.

Minutes from the January meeting were released last week. Unlike December, the tone of January’s meeting was more measured, with Chair Powell repeatedly pushing back on expectations of a March hike. This was a sentiment echoed in the minutes, with participants confirming that “the policy rate was likely at its peak for this tightening cycle" but noting that “they did not expect” it would be appropriate to reduce the target range for the federal funds rate until they had gained greater confidence that inflation was moving sustainably toward 2%. These remarks were greeted with a modest sell off in bonds, but further volatility is possible. Participants also “observed that they would be carefully assessing incoming data in judging whether inflation was moving down sustainably toward 2%." Given that this meeting took place before the latest CPI and unemployment data, it is possible that participants need greater confirmation still that inflation will be sustainably under control.

UK public borrowing is once again in focus, ahead of next week’s Budget. The good news for the Treasury is that borrowing in the current tax year is undershooting expectations. January saw a surplus of £16.7bn, ahead of the £7.5bn surplus in 2023. A surplus is usual in January, as HMRC books tax receipts, but lower inflation has also allowed interest on RPI-linked instruments to fall again, leading to lower spending. This is the main driver behind total expenditure of £102.6bn, below the OBR’s forecast of £103.9bn.

Does this create room for tax cuts next week? Certainly, the Chancellor will be keen to enact measures that might boost popularity with the electorate. The better-than-expected turnout for spending helps create headroom for tax cuts, with lower inflation expectations, a lower path for rates and lower expected interest payments likely to make the OBR’s forecast more favorable. The Government’s own fiscal rules also allow a good degree of flexibility, only requiring debt as a percentage of GDP to be falling in the final year of the forecast.

 

 

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