Growth There, To Defend

The Chinese want banks there to lend
In order to get folks to spend
So now banks need hold
Less cash, we are told
As Xi tries, growth there, to defend

Chinese banks are feeling a bit sprightlier this morning after the PBOC announced yesterday that they were cutting the required reserve ratio (RRR) by 50bps. This will release roughly $100 billion into the Chinese economy over time and should certainly act as a stimulant. As is typical, though, the PBOC has instructed the banks there on just how to use these funds. It seems that large banks are going to be required to increase debt/equity swaps with large, mostly state-owned, borrowers in order to prevent those firms from deteriorating further. (None of these banks are happy about this.) Meanwhile, small banks have been instructed to increase lending to the private sector SME’s.

The recent data from China has consistently disappointed and the escalating trade rhetoric between the US and China clearly has President Xi somewhat spooked. The last thing he can afford is for Chinese growth to slow significantly, especially if he is seen as part of the cause based on the trade dispute. It should be no surprise, then, that CNY has fallen a bit further this morning (-0.6%) in the wake of this activity, and it is actually now lower on a YTD basis. The currency remains one of the key safety valves for the Chinese economy, and especially given the broader global growth slowdown that appears to be occurring, I expect its weakness to continue. While the PBOC needs to be wary of allowing it to decline too rapidly, for fear that it will encourage significant capital outflows, a gradually weaker yuan is a very likely outcome as the year progresses.

The other noteworthy news from the weekend was the Turkish election, where President Recep Erdogan claimed victory with ~52.5% of the vote. In addition, his AKP party also won a majority in parliament, which means that he will be able to continue to strengthen his grip on power. The market’s initial reaction was for a TRY rally of as much as 3.0%, but it has already ceded all of those gains and is now lower by 0.2% as I type. Remember, Erdogan’s view is that high interest rates are the “mother and father of all evil” and he has promised to take a more active role in monetary policy now that he has won the election. Look for the lira to continue to decline, with 5.00 soon to be breached and 6.00 probably not that far behind.

But away from those stories, there is not much to discuss. German Ifo data printed at 101.8, which was 0.1 higher than expected, but still represents the sixth decline in the past seven months and is now at a more than one year low. In other words, nothing has changed with regards to the idea that the Eurozone economy is slowing down further, diverging from the ongoing growth story in the US. However, the euro is barely softer this morning, just 0.1%, as it continues to consolidate its gains from late last week. At the same time, the pound has fallen 0.25% despite a lack of economic news. It appears that the lack of positive movement on the Brexit talks is beginning to weigh more forcefully on the currency. The pound is down more than 5% this quarter, and by all indications, there is no solution in the offing for the more intractable Brexit issues, notably the Irish border and the transition arrangements. There are but nine months left before the UK is going to exit the EU and it increasingly looks like there will be no deal in place when it occurs. Despite the fact that the market is currently pricing in a 65% probability of an August rate hike, I remain of the view that the BOE is going to be on hold for quite a while yet.

Turning to the US, we see a bit of important data this week as follows:

Today New Home Sales 667K
Tuesday Case-Shiller Home Prices 6.8%
  Consumer Confidence 128
Wednesday Durable Goods -0.6%
  -ex transport 0.4%
Thursday Initial Claims 220K
  Q1 GDP (3rd look) 2.2%
Friday Personal Income 0.4%
  Personal Spending 0.4%
  Core PCE 0.2% (1.9% Y/Y)
  Chicago PMI 60.0
  Michigan Confidence 99

Durable Goods is likely to be the most carefully scrutinized, although the PCE data on Friday can clearly have an impact, especially if it is weaker than expected. We also hear from five more Fed speakers, mostly hewing from the center or dovish side of the spectrum. In the end, unless we see a major trade breakthrough, I expect that the US story is going to continue to be one of economic outperformance for now, tighter monetary policy and continued gradual strength in the dollar.

Good luck