China & Fed Lift-Off Dominate Market Trends – Why? by Gary D. Halbert
FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
October 27, 2015
IN THIS ISSUE
- Is China’s Economy in Trouble? The Answer is Maybe
- China’s “Fifth Plenum” Gathering in Beijing This Week
- Fed Lift-off: Not Tomorrow, December Move Still Uncertain
- Advance 3Q GDP Report Expected to Disappoint on Thursday
- Is America Still #1 in the World? – Maybe Not, Unfortunately
Is it just me, or does it seem like the global markets are preoccupied with two things: China’s economy and when the Federal Reserve will raise US interest rates? Sure, there are other things going on, but these two topics seem to be driving the financial markets more than any others this year.
In that light, we will begin today with a look at China’s latest economic report last week which received mixed reviews among economists. While China’s economy is slowing, growth is still officially near a 7% annual rate. Even if it’s only 5-6%, as many believe, a recession is not likely in China anytime soon.
Following that discussion, I will touch briefly on the Fed’s policy meeting that began today and ends tomorrow. Most Fed-watchers, including me, don’t expect any surprises tomorrow, but you never know. On the subject of the Fed, there is increasing talk about short-term interest rates going below zero. I’ll briefly explain what that’s all about.
While China and the Fed seem to dominate the headlines and financial market trends, there is a very important report coming out this Thursday. That’s when we get the government’s first estimate of 3Q GDP. The pre-report consensus is at 1.7% with some estimates as low as only 1.0%. If correct, that means the strong growth in the 2Q (3.9%) did not carry over during the summer.
Finally, I will close out today’s letter by summarizing the most interesting article I read last week.
Is China’s Economy in Trouble? The Answer is Maybe
Last Friday at the end of the day, the People’s Bank of China (PBOC) cut its key interest rate for the sixth time in the last year. The move came as a surprise to many around the world since China had just announced that its economy grew by 6.9% (annual rate) in the 3Q, which was slightly better than the pre-report consensus of 6.8%. So why the need to cut rates yet again?
The answer is that the Chinese economy is not as strong as its communist leaders would have us believe. While most countries would kill for 6.9% GDP growth, that is the lowest level for the Chinese economy since a 6.2% reading in the 1Q of 2009 during the global financial crisis.
Many global forecasters believe that nominal GDP growth in China has slowed to 6.2% at best, and many believe it is even slower as I will discuss below. This is translating into weak cash-flow for many Chinese companies that already face high debt burdens.
China’s industrial sector has been especially hard hit, with the country’s northern rustbelt on the brink of a recession. And more than a percentage point of overall growth this year has stemmed from activity in the financial sector, a contribution that is falling away quickly in the wake of this summer’s stock market plunge.
As a result, many analysts now believe that China’s real growth is closer to 5-6%, well shy of the government’s 7% target. In addition, China has experienced three years’ worth of wholesale price deflation, and although we don’t hear much about this, it clearly is a drag on the economy. However, even if China’s growth is only 5-6%, that doesn’t suggest a recession anytime soon, as many have feared over the last few months.
Last Friday’s surprise interest rate cut was also accompanied by yet another reduction of banks’ reserve requirements for the fourth time in the last year. Big banks now must set aside only 17% of their deposits as reserves. This means that China’s banks now have more money to lend if they choose to.
By the way, all of China’s monetary policy moves are, strictly speaking, surprises. The central bank does not hold scheduled meetings, as most central banks do, and it often waits until the end of the day on Fridays to make big announcements, giving the markets time to digest the implications over the weekend.
This latest easing is also a reminder that the PBOC has actually been cautious thus far, leaving itself plenty of space if it wants to deliver more easing just ahead. Even after the succession of cuts this year, the PBOC’s one-year benchmark lending rate stands at 4.35%. Most analysts expect the central bank to continue to cut rates periodically into early next year, until it is satisfied that the economy has stabilized.
There have in fact been some tentative signs of improvement recently. Property sales have picked up of late, and that has begun to filter into more construction. A push for infrastructure investment has started to gain traction. Income growth and consumption, meanwhile, have so far remained resilient, showing little lasting impact from the recent stock market meltdown.
All that helps explain why China’s stimulus moves, both fiscal and monetary, have come in small doses over the past year and are likely to continue. Growth is slower than advertised, but the bottom is not falling out. Recession fears are overblown.
China’s “Fifth Plenum” Gathering in Beijing This Week
As you read this, China’s top brass are meeting in Beijing for the Fifth Plenary Session – a key four-day annual policy-setting meeting that will be closely watched by investors worldwide. As the name suggests, the Fifth Plenum is the fifth out of seven major meetings held by the Communist Party’s Central Committee, a political body that is made up of the Party’s top leaders.
The Fifth Plenary Session is typically highlighted by a new Five-Year Plan (FYP) for the country, which will include major economic, monetary and development goals and guidelines. The 100+ page document will contain both qualitative goals, such as “building a moderately prosperous society by 2020” as well as quantitative targets on economic, social and environmental issues.
This year’s FYP is the first to be produced under President Xi Jinping’s leadership and comes at a time when China’s economic growth is forecast to decelerate further. It also comes in a year when the Chinese government has already taken some unprecedented actions.
The Chinese government’s intervention in its stock market and the devaluation of the renminbi (yuan) this summer provided a loud reminder that economic developments in China affect everyone. And there is every expectation that China’s leaders will make more world-shaping decisions at this week’s meeting.
Two years ago at the Third Plenum, China’s leaders committed to pursue far-reaching reforms, declaring that markets must “play a decisive role in allocating resources.” While the government would continue to play the leading role in providing public goods and services, policymakers would “unwaveringly encourage, support and guide the development of the non-public sector and stimulate its dynamism and creativity.”
What this means is that China’s leaders are trying to reform and turn more control over to the private sector and the markets. Yet China certainly faces serious challenges this year with slowing