Dissatisfaction

The Chinese would have us believe
Their growth targets, they will achieve
Alas, recent data
When looked at pro rata
Shows trust in their words is naïve

Meanwhile, in the UK, inflation
Is rising across that great nation
The market’s reaction
Is dissatisfaction
Thus, Gilts have seen depreciation

Just how fast is China’s GDP growing?  That is the question to be answered after last night’s data dump was distinctly worse than expected.  The big outlier was Retail Sales, which grew only 2.5% Y/Y in August, down from 8.5% in July and far below the expected 7.0% forecast.  But it was not just the Chinese consumer who slowed down their activity, IP rose only 5.3% Y/Y, again well below the July print of 6.4% and far below the forecast of 5.8%.  Even property investment was weaker than forecast, rising 10.9%, down from 12.7% in July and below the 11.3% forecast.  So, what gives?

Well, there seem to be several issues ongoing there, some of which may be temporary, like lockdowns due to the spreading delta variant of Covid, while others are likely to be with us for a longer time, notably the fallout from the bankruptcy of China Evergrande on the property market there.  The Chinese government is walking a very fine line of trying to support the economy without overstimulating those areas that tend toward speculation, notably real estate.  This is, however, extraordinarily difficult to achieve, even for a government that controls almost every lever of power domestically.  The problem is that the Chinese economy remains hugely reliant on exports (i.e. growth elsewhere in the world) in order to prosper.  So, as growth globally seems to be abating, the impact on China is profound and very likely will continue to detract from its GDP results.

Adding to the Chinese government’s difficulties is that the largest property company there, Evergrande, is bankrupt and will need to begin liquidating at least a portion of its property portfolio.  Remember, it has more than $300 billion in USD debt and the government has already said that interest and principal payments due next week will not be made.  A key concern is the prospect of contagion for other property companies in China, as well as for dollar bonds issued by other Chinese and non-US entities.  History has shown that contagion from a significant bankruptcy has the ability to spread far and wide, especially given the globalized nature of financial markets.  While we will certainly hear from Chinese officials that everything is under control, recall that the Fed assured us that the subprime crisis was under control, right before they let Lehman Brothers go under and explode the GFC on the world.  The point is, there is a very real risk that investors become wary of certain asset classes and risk overall which could easily lead to a more severe asset price correction.  This is not a prediction, merely an observation of the fact that the probability of something occurring has clearly risen.

Speaking of things rising, the other key story of the morning is inflation in the UK, which printed at 3.2%, its highest level since March 2012, and continues to trend higher.  This cannot be surprising given that inflation is rising rapidly everywhere in the world, but the difference is the BOE may have a greater ability to respond than some of its central bank counterparts, notably the Fed.  For instance, the UK debt/GDP ratio, while having risen recently to 98.8%, remains well below that of the rest of the G7, notably the Fed as the US number has risen to around 130%.  As such, markets have begun to price in actual base rate hikes by the BOE, looking for the base rate to rise to 0.50% (from 0.10% today) by the end of next year with the first hike expected in May.  While that may not seem like much overall (it is not really), it is far more than anticipated here in the US.  And remember, our CPI is running above 5.0% vs. 3.2% in the UK.

The upshot of the key stories overnight is that taking risk is becoming harder to justify for investors all over the world.  While there has certainly not yet been a defining break from the current ‘buy the dip’ mentality, fingers of instability* seem to be developing throughout financial markets globally.  The implication is that the probability of a severe correction seems to be growing, although the timing and catalyst remain completely opaque.

So, how has the most recent news impacted markets?  Based on this morning’s price action, there is clearly at least some concern growing.  For example, equity markets in Asia were all in the red (Nikkei -0.5%, Hang Seng -1.8%, Shanghai -0.2%) as the fallout of slowing Chinese growth and the China Evergrande story continue to weigh on sentiment there.  In Europe, the continent is under some pressure (DAX -0.1%, CAC -0.5%) although the UK (FTSE 100 +0.1%) seems to be shaking off the higher than expected CPI readings.  As to US futures, as I type, they are currently marginally higher, about 0.2% each, but this follows on yesterday’s afternoon sell-off resulting in lower closes.  Nothing about this performance screams risk-on, although it is not entirely bad news.

The bond market seems a bit more cautious as Treasury yields have fallen further and are down 1.3bps this morning after a 4bp decline yesterday.  This is hardly the sign of speculative fever.  In Europe at this hour, yields are essentially unchanged except in Italy, where BTP yields have risen 1.6bps as concerns grow over the amount of leeway the Italian government has to continue supporting its economy.

Commodity markets show oil prices continuing to rise (WTI +1.35%) after inventory numbers continue to show drawdowns and Gulf of Mexico production remains reduced due to the recent hurricane Nicholas.  While gold prices are little changed on the day, both copper (+0.6%) and aluminum (+1.6%) are firmer on supply questions.  Certainly nothing has changed my view that the price of “stuff” is going to continue higher in step with the ongoing central bank additions of liquidity to markets and economies.

Finally, the dollar is under pressure this morning, which given the risk-off sentiment, is a bit unusual.  But against its G10 brethren, the greenback is lower across the board with NOK (+0.85%) the clear leader on the strength of oil’s rally, although we are seeing haven assets CHF (+0.4%) and JPY (+0.4%) as the next best performers.  The rest of the bloc has seen much lesser gains, but dollar weakness is clear.

The same situation obtains in the EMG markets, where the dollar is weaker against all its counterparts, although the mix of gainers is somewhat unusual.  ZAR (+0.5%) is the top performer on the back of strengthening commodity prices and it is no surprise to see RUB (+0.4%) doing well either.  But both HUF (+0.45%) and CZK (+0.4%) are near the top of the list as both have seen higher than forecast inflation readings recently and both central banks are tipped to raise rates in the next two weeks.  As such, traders are trying to get ahead of the curve there.  The rest of the bloc is also firmer, but the movement has been much less pronounced with no particular stories to note.

On the data front this morning, Empire Manufacturing (exp 17.9), IP (0.5%) and Capacity Utilization (76.4%) are on the docket, none of which are likely to change many opinions.  The Fed remains in their quiet period until the FOMC meeting next week, so we will continue to need to take our FX cues from other markets.  Right now, it appears that 10-year yields are leading the way, so if they continue to slide, look for the dollar to follow suit.

Good luck and stay safe
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*see “Ubiquity” by Mark Buchanan, a book I cannot recommend highly enough

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