In this week’s edition: the bamboo curtain; assessing Chinese growth: more ‘L’ than ‘V’; and the Fed in context.
December 11 2018
The Bamboo Curtain
While the US and China have – on the surface – agreed to a halt in tariffs, we believe there is a strong case that a more serious fundamental shift is underway.
First, the gulf between the two countries is neatly captured by communications released after the G20 dinner on 2 December (Figure 1). Chinese officials did not mention that the suspension of tariff increases from 10% to 25% was for a limited time period. In contrast, US officials stressed that the suspension of the increase in tariffs was contingent on successful negotiations on a range of issues, including intellectual property and forced technology transfer, alongside a concerted programme of purchasing by China to reduce the US trade deficit, all of which must be completed in 90 days.
Indeed, US Vice-President Mike Pence’s speech to the Hudson Institute on 4 October roundly condemned Chinese increased military activity, trade practices and human rights record, and promised increased American action in response. At the time, he declared that the US administration would “continue to act decisively to protect American interests, American jobs, and American security. As we rebuild our military, we will continue to assert American interests across the Indo-Pacific.” This is an exceptionally hawkish statement, even by the standards of an administration which is not known for mincing its words. This has been seen as a parallel of Winston Churchill’s ‘Iron Curtain’ speech about the USSR in 1946, which marked the beginning of the Cold War.
As such, given such palpable differences between the two countries’ viewpoints, and a steadying worsening of relations, we remain cautious when considering ‘thaws’ in US-China relations.
Figure 1. Differences in Statements Between US and China After G20 Dinner
Source: Man Group, CGTN, WhiteHouse.gov
Assessing Chinese Growth: More ‘L’ Than ‘V’
Deleveraging remains the number one priority for the Chinese economy, in our view.
Figure 2 shows three different measures of Chinese growth. Official year-on year GDP growth was 6.5% as of 30 September, the lowest since March 2009. Year-on-year growth in M1 – often described as ‘narrow money’ i.e. banknotes, coins, and overnight deposits – was 2.7% in October, down from 13% in October 2017 and 23.9% in October 2016. Such a steep fall is indicative of a much more rapid slowdown than that implied by other indicators or the official figures. Growth calculated using the ‘Li Keqiang’ indicators – a combination of electricity consumption, railway cargo volume and bank lending – was at 8.75% year-over-year as of 31 October, up 0.75 percentage points from the same month the year before, but down from 11.22% year-on-year in January 2018.
The decline in both Li Keqiang and M1 growth rates imply a reduction in lending activity. As such, we believe that the Chinese stimulus has only just arrested the underlying rate of deceleration, and that any economic recovery will tend to be more ‘L’ shaped, rather than ‘V’ shaped.
Figure 2. Measures of Chinese Growth
Source: Bloomberg, as at 31 October 2018
The Fed in Context
Markets have been focused on Federal Reserve Chair Jerome Powell’s somewhat contradictory statements over the last months about the neutral rate. Rather than parsing the entrails of his announcements, it may be worthwhile to look at supply-side factors driving inflation, in our view.
Unit labour costs tend to lead inflation by about 12 months. Figure 3 below compares current US unit labour costs to US Core CPI, with unit labour costs leading CPI by 12 months. The US year-on-year core CPI stood at 2.1% as of October 2018, just above the Fed’s target rate of 2%. US unit labour costs grew at 1.3% year-on-year in October 2018. Indeed, the US unit labour costs have been on a downward trend since September 2017.
With no signs of cost-push to drive inflation it seems unlikely to us that the Fed will look to increase the pace of rate hikes.
Figure 3. US Unit Labour Costs Versus US Core CPI
Source: Bloomberg, as at 30 September 2018. Note: US unit labour costs represents a 12 month leading indicator.
With contribution from: Ben Funnell (Man Solutions, Portfolio Manager), Henry Neville (Man Solutions, Analyst) and Ed Cole (Man GLG, Portfolio Manager).