Despite the gloom surrounding China’s economy – which, according to official data, grew in the last quarter of last year at its since 2009 – sentiment in financial markets has improved noticeably since the start of this year. Having plummeted 25 per cent in 2018, the is up 5.8 per cent, while the yuan has risen to its strongest level against the US dollar in six months.
Investors’ willingness to disregard poor economic data stems partly from external factors, notably recent statements from the Federal Reserve indicating that it would take a approach to tightening monetary policy, given the slowdown in the global economy. Yet it is the domestic driver of the rally – hopes that more stimulus measures will boost Chinese growth – that warrants closer attention.
As I have argued, many investors believe that the mantra – the view that weak economic data makes stronger stimulus measures more likely – now applies to China. Since Beijing began to last summer, its drip-feed approach to monetary and fiscal loosening has somehow convinced many fund managers that the pace of easing will quicken as the imperative of halting the slowdown becomes more urgent.
This is a questionable assumption. China’s policy regime is bedevilled by contradictory objectives. Beijing’s determination to eschew the heavy-handed stimulus measures of the past is matched only by its fear of a sharper downturn, increasing the risk China’s economy ends up with the worst of both worlds: an excessive let-up in deleveraging and not enough growth. There is no solid basis for a sustained stimulus-led rally in stock markets, given the acute tensions between the government’s debt-cutting efforts and the pressing need to stimulate demand.
However, China is by no means alone among the world’s largest economies in facing policy uncertainty.
At its policy meeting last Thursday, the European Central Bank left itself open to criticism by downgrading its outlook for the euro-zone’s economy only a month after it ended its four-year quantitative easing programme. What is more, ECB president Mario Draghi refused to say whether the central bank would change its official guidance, which leaves scope for a rate hike as early as this autumn.
That the ECB is still deliberating whether to begin increasing rates later this year, when data published last week revealed that the manufacturing sector of Germany, the euro-zone’s biggest economy, is contracting and that growth in the bloc has slowed to a 5½-year low, is sufficient reason to fear a policy mistake is in the offing. As IHS Markit, a business information provider, rightly observed last week, current economic conditions in the euro zone are “more associated with the ECB loosening rather than tightening policy”.
The ECB’s policy settings are even more questionable when viewed in the context of the Fed’s recent decision to hold off raising rates further until the impact of the global slowdown becomes clearer. If the Fed is sufficiently concerned about the state of the United States economy, which continues its brisk growth, then the ECB should already be signalling a looser policy stance, when the conditions in Europe are significantly weaker.
Yet the Fed, too, remains a source of significant volatility. While markets have rallied since the start of 2019, mainly because of the US central bank’s dovish tilt, the degree to which the Fed will ease off its normalising policy – both with regard to borrowing costs and the unwinding of its balance sheet – remains unclear and could prove to be a disappointment to investors.
Although numerous signals in recent weeks from Fed policymakers, including chairman Jerome Powell, suggest the central bank will proceed prudently, investors remain overly pessimistic about a US economy that is close to full employment and is enjoying a strong pickup in wage growth. In a report published last Friday, JPMorgan said it expects the Fed “will avoid giving the impression that a [rate] pause equals stop or that the economic outlook has materially downshifted”.
When set against an ECB that is slow to react to the sharp slowdown in the euro zone and a Fed that may prove much less dovish than expected, China’s policy response, although lacking credibility due to Beijing’s conflicting goals, starts to look like a more plausible catalyst for a rally.
At least Beijing is moving in the direction favoured by investors, having sent a sufficient number of signals since July, and taken a series of targeted measures, to convince market participants that additional stimulus is on the way. In comparison with the Fed and the ECB, there is more scope for Beijing to surprise markets positively (especially if the collapse).
Investors are too sanguine about the scale and efficacy of Chinese stimulus. But it is the policies of the ECB and the Fed that may give markets more cause for concern this year.
Nicholas Spiro is a partner at Lauressa Advisory