The Chinese are starting to feel
Recession could really be real
With PMI falling
Most pundits are calling
For policy help with more zeal

But so far, despite lots of talk
The Chinese will not walk the walk
One wonders how long
That they’ll sing this song
And when they’ll stop acting the hawk

Right now, the face of ‘all talk, no action’ is Chinese President Xi Jinping.  China’s economy has been slowing, or perhaps a better description is that the post-covid performance has been much less dynamic than had been widely anticipated.  Amongst the more concerning lowlights is the incredibly high youth unemployment rate there, with >21% of the population aged 18-24 unable to find work.  That is not the sign of economic dynamism.  You may recall the enthusiasm that greeted the news that the Covid lockdowns had ended suddenly in January and there was a widespread call for a rally in commodity prices in anticipation of the great reopening.  It never really happened.  Since then, things have been lackluster at best and the Chinese government has grown increasingly concerned.  However, they have not yet grown concerned enough to act in any significant way with fiscal policy support extremely narrow and inconsistent.

Last night simply reinforced these themes as the Caixin PMI Manufacturing data was released at 49.2, a full point below expectations and, of course, below the key 50 level indicating growth.  This was the lowest print since December, but a quick look at the numbers since then shows a very limited growth impulse in China.  The average reading in 2023 has been 50.1, hardly a sign of a rebound.  Now, the Chinese government did come out and say they are going to increase credit to private companies, focusing on small firms and the central government called on cities and provinces to do more to support the property markets.  But talk is cheap and until we see real money getting spent, it is hard to get excited about the Chinese economy.  Ultimately, while the PBOC is very concerned that the renminbi could fall sharply if they loosened their grip on the currency, I expect that a weaker CNY is going to be a theme for the rest of this year, and probably most of next year, as it offers the one release valve that they have available.  7.50 is still in the cards.

Away from the China story, the market’s focus on central banks intensified as the RBA left rates on hold at 4.10% despite market expectations of a 25bp rate hike.  The first casualty of this surprise was the AUD (-1.3%) which is the worst performing currency across the board today.  Apparently, their concern is that growth is faltering, and given the lack of growth in their largest export market, China, they believe that inflation pressures are ebbing and they have achieved their objectives.  Like all central banks these days, they claim to be data dependent and right now the data are telling them not to worry.  I guess that means when if inflation starts to reaccelerate, they will be back at the hiking game.  But for now, like central bankers all over the world, they are eager to claim victory over inflation.  

We heard this from the ECB last week, and it is quite possible that the BOE hints at that on Thursday as well, although inflation is much stickier in the UK than elsewhere.  My point is that the one central bank that is not satisfied is the Fed, where there is still a very wide consensus that the job is not done.  As long as US economic activity remains the best around, and that seems highly likely for another few months at least, it is hard to see any other central bank maintaining a more hawkish stance than the Fed.  Again, the underlying thesis of dollar strength is the Fed will be the most hawkish of all, and nothing we have seen today would contradict that theory.

How have markets responded to this news?  Well, yesterday saw a very late rally to take the US indices higher on the day, but only just, and while the Nikkei (+0.9%) had a good session, continuing its recent run, Chinese stocks, not surprisingly, were weighed down by the baggage of the PMI data.  Europe is also feeling the brunt of weak PMI data as the Manufacturing prints there were all in the low 40’s, except for Germany which managed to remain unchanged at 38.8!  Virtually all the markets on the continent are down by around 1% this morning in response to the data.  In fact, it is data like this that helped inform Madame Lagarde’s belief that the ECB is done, and who can blame her.  While inflation may be a problem, and the ECB’s only mandate, given she is a politician first and central banker second, the optics of tightening policy into a rapidly declining economy would be very difficult to explain.  Again, this bodes well for the dollar overall.  As to the US futures market, they are a bit softer this morning, not dramatically so, but it seems that there is some response to a generally softer tone in the earnings numbers released to date.

Interestingly, despite equity weakness, bond yields are higher in the US and across Europe by a few basis points.  For some reason, the bond market does not seem to agree with stocks, nor it seems, with most central bankers.  Inflation concerns remain top of the list for bond investors, and other than Down Under, where AGBs fell 8.6bps after the RBA left rates on hold, there seems to be a growing worry that the central banks are ending their fight too soon.  As to the US, once again the 10-year yield is approaching 4.0%, clearly a level of great import to the market.  I would also note that JGB yields edged ever so slightly lower overnight and remain below 0.60%.  However, it is still early days with respect to the policy changes there, so the eventual outcomes are still unclear.

Oil prices are very little changed today, consolidating their recent gains.  This must be a concern for the central banks as evidence of slowing economic activity is not leading to slowing demand for oil.  That is a key tenet of their policy structure.  The belief is weaker growth and recession will reduce demand for energy first, and then other things thus reducing inflationary pressures.  But if growth weakens and oil stays firm or rallies, they have a big problem.  Now, the metals complex is all softer this morning, behaving as would be expected in a weakening growth scenario, so it is oil that is the current outlier.

As to the dollar, it is king of the hill this morning.  While Aussie is the weak link, all the commodity currencies are under pressure, down between -0.6% and -0.9%.  But the yen (-0.5%) is also failing to find support on a risk-off day, which comes as a bit of a surprise to all those who continue to believe the BOJ is going to alter policy further.  Here, too, I see further weakness vs. the dollar as time progresses.  Just wait until the Fed hikes again and sounds hawkish as CPI data rebounds.

In the emerging markets, ZAR (-1.4%) has now edged ahead of the Aussie for title of worst of the day, as a response to the Chinese data, its own weak PMI reading and declining metals prices.  But virtually the entire bloc is weaker today with all three geographic areas feeling the pain.  

Yesterday’s US data was definitely soft with Chicago PMI at 42.8 and Dallas Fed at -20.0.  As well, the Senior Loan Officer Opinion Survey indicated that credit conditions for commercial and industrial loans had tightened further with reduced demand to boot.  In fact, the tightening is reaching levels last seen during the covid recession and the GFC.  This is not indicative of a soft landing, rather of a much harder one.  This morning we see Construction Spending (exp 0.6%), JOLTS Job Openings (9600K) and ISM Manufacturing (46.9) all at 10:00am.

And yet, despite the data and SLOOS, we heard from Goolsbee and Kashkari that they continue to believe a recession will be avoided.  This morning, Goolsbee is back on the tape, but we already know his view.  However, I do not believe he is in the majority at this point, though he is a voter, so come September, if they hike, perhaps we will have a dissent.

If the data is terrible, perhaps we will see the dollar cede some of this morning’s gains, but absent that outcome, let alone surprising strength, it feels like the dollar has further to rally.

Good luck

Adf