Nolan Stanton

Market Commentary

For the week ending 03 August 2018
Report by Nolan Stanton
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Nolan Stanton

China economic data weakens, the central Government or People’s Bank of China (PBoC), stimulates credit or loosens fiscal restraints – 6% Gross Domestic Product (GDP) is miraculously achieved.

So, we entered 2018 and President Trump attempted to stick it to President Xi, ‘New York style’ over trade between the two countries. The Chinese responded in kind and then to offset the impact of a trade battle, having been attempting to deleverage debt, opened the Government wallet (again). The PBoC subsequently provided an unprecedented amount of medium-term lending to commercial banks, which will expand the money supply. Then, the Central Bank moved the goal posts over capital requirements, freeing commercial banks up to lend more to less stable borrowers. It should also be remembered, the PBoC has already cut its reserve ratio requirement for banks three times in 2018. Not wanting all the largesse to be seen to emanate from the Central Bank, the Chinese Government then fired the fiscal cannon. China is reported (by Reuters) to be putting more money into bridges and roads (infrastructure), as well as easing borrowing curbs on local authorities to deal with the consequences of a possible trade war with the USA. Perhaps unsurprisingly, this has not gone unnoticed. The iBoxx China High Yield Total Return Index, which lost nearly 8% from January to mid July in a slow grind, has promptly recouped half of that downdraft in less than two weeks.

Of some concern to the rest of the planet was the reaction of the Chinese currency, the Renminbi (RMB). The RMB is on course for completing a near two month drop against the US Dollar. Measured from late Spring, the annualised decline of the RMB versus the US Dollar, is 25%. In the Summer of 2015, the fall in the RMB versus the US Dollar was put down to the wall of outflows, as wealthy Chinese sought to get their money out. One argument suggests that the depreciation of the RMB, if not an outright policy manoeuvre by the PBoC, is broadly in line with Chinese strategic interests. China wants to weaken its currency in response to President Trump’s tariffs and a slowing economy. The counterview, put forward by J Capital Research, suggests that China’s credit saturated economy (bank assets topped last year’s GDP by more than 300% and represent more than half of the 2017 world GDP), is the primary force behind the recent currency gyrations, whilst also arguing that the politburo might ultimately hold less sway on the exchange rate than is widely believed. The reality is that China’s currency is most intimately connected, as with any currency, to the domestic economy – debt, asset prices, real estate prices and efficiency gains and losses, rather than just trade. On that basis, this is the time for depreciation.

The Communist party needs stability and economic growth to sustain its legitimacy. However, if the currency continues to drop, this could be put to the test. We doubt ‘the Donald’ will lose any sleep over it. Keep an eye on the RMB.