Bilal’s Macroscope: The 4 Most Important Things to Know About the China Slowdown
- By Bilal Hafeez
- 3 min read
Punch line: China has a credit and real estate problem, that prevents policymakers from easily boosting the economy.
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Punch line: China has a credit and real estate problem, that prevents policymakers from easily boosting the economy. Domestic demand is weak, while exports are now turning down. The slowdown theme has further to run. This means lower China yields, regional stock markets (HK, KOSPI) and metals (iron ore) could weaken further. In FX, selling CNH/JPY could be attractive.
1. China has a credit problem. China has undergone a credit boom since the GFC. This means more lending and debt issuance than ever before. As a share of GDP, the rise has been way bigger than (say) India (Chart 1). At the same time, Chinese growth has been less than pre-GFC. This means that the credit intensity of the economy has surged. In fact, last year, it took 13 RMB of credit to generate 1 RMB of growth (Chart 2). Before the GFC, it was one to one. This helps explain why Chinese policymakers have been unable to boost growth this year. The credit channel is becoming problematic to use. China ends up with way higher debt and not much more growth.
2. The largest sector, real estate, is broken. According to work by Ken Rogoff et al, 30% of China’s economy is linked to real estate (Chart 3). This is double that of the US. At the same time, China has seen an unprecedented property price boom (Chart 4). So, you have a massive sector that is overvalued. It is no wonder we are hearing stories of defaults. From a macro perspective, this adds another headache for policymakers, they cannot use real estate as the way out of a growth slump.
3. Weak domestic demand, and exports turning down. With weak real estate, China will need to rely on alternative sources of demand. One is the consumer, but the signs are poor on that front. Retail sales are below the pre-COVID trend (Chart 5). Then there are exports, which has saved China’s growth since COVID, but they peaked in late 2022 and have been falling ever since. And while China’s auto and battery exports have stayed strong, they are not large enough to stem the tide on overall exports (Chart 6).
4. How to play China’s weakness. One challenge with the China slowdown theme is that markets have been pricing weakness. China bond yields have been falling, and iron ore prices have broadly been consolidating (Chart 7). Nevertheless, if the slowdown persists, these markets could continue to fall. Our bias would therefore be long China rates and bearish metals.
Looking at which other markets are correlated to China’s growth, using China 10y yields and iron ore as a proxy, we find regional Asian stock markets, like HK, and industrial metals, like copper and aluminium, stand out (Chart 8). There appears to be little spillover to broader DM markets, whether US rates or global equities.
On FX, USD/CNH has risen sharply and it appears authorities have taken notice by adjusting the daily fix lower. Nevertheless, a weaker currency is one of the few levers that policymakers have to stimulate growth (via exports). Therefore, they may prefer currency weakness, albeit orderly weakness. More specifically, we find that CNH has reached new lows against the USD, but the CFETs basket has not (Chart 9). This suggests that playing CNH weakness against other crosses in the CFETs basket may make more sense. The one that stands out is CNH/JPY, which remains at elevated levels (Chart 10). Therefore, a short CNH/JPY could make sense. What helps this trade is that the PBoC is dovish, while the BoJ is leaning hawkish, valuations support the trade and while it is negative carry, it is smaller than USD/JPY or EUR/JPY.