US economy

China’s credit pulse has a kick


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Plenty of attention will focus on the signing of a “phase-one” trade deal between the US and China on Wednesday, but that event is eclipsed by another important signal: a positive change in the infusion of new credit as a percentage of China’s economy.

The supply of new credit represents the lifeblood for economies and markets — one only has to look at how far equities have rallied in the wake of the Federal Reserve expanding its balance sheet (see Quick Hits). And earlier on Tuesday, during JPMorgan’s earnings call, chief executive Jamie Dimon acknowledged the Fed’s expansionary policy was a “tailwind for us” alongside robust growth, as the largest US bank reported record annual profits.

The latest credit impulse signs from Beijing are promising, as shown here via Saxo Bank, although the pick-up remains in the early stages.

Christopher Dembik at Saxo writes how the credit impulse is a leading indicator, “which leads the real economy by nine to 12 months” and “is back in positive territory for the first time since the end of 2017, running at 0.7 per cent of GDP”. He concludes:

“This is certainly one of the most important macroeconomic news of the past months. As China represents about one-third of global growth impulse, positive credit impulse means we could see the constructive global ripple effects in the coming months.”

Just how far the credit impulse rebounds is an important point of conjecture as 2020 unfolds. Still, the data serves as another source of support for the global economy while, at the very least, a US and China “bare bones” trade agreement helps lower the political risk temperature. A crucial element of the trade truce has been a firmer renminbi, while Tuesday’s news that Chinese imports and exports in December were better than forecast (albeit from a low base, as noted by analysts) only instils a sense of new-year optimism for Asia, emerging markets, not to mention European luxury goods makers.

Still, there are limits for all markets. In that regard, Marc Chandler at Bannockburn Global Forex makes the point that further strength in the renminbi risks offsetting easier monetary policy from Beijing. So don’t be surprised if the currency sets a peak around the signing of the trade treaty this week. As Mark notes:

“Is it too cynical to suggest that the yuan records a high around the signing of the trade agreement?”

Reader feedback

A reader, who recently conveyed a very nice message about Market Forces, asked for more coverage on Brazil, pointing out that it is the “world’s fifth-largest economy, blissfully cushioned from war, earthquakes and tsunamis . . . has its own petroleum reserves and is trying really hard”.

Now, Market Forces does try to keep its eyes peeled across global markets and Brazil is certainly an important area. Fortunately, the FT has a resident expert on all matters Brazil in Jonathan Wheatley. He has kindly written this short piece for Market Forces readers.

Brazilian assets are on a tear. The Bovespa stock market index is hitting record highs and spreads on 10-year government bonds, at under 5 percentage points, are less than half of what they were 18 months ago.

In a world dominated by the US and Chinese economies, Brazil is off on its own to some extent. As a relatively closed economy it is less exposed than others to global swings, and its consumer economy is big enough to act as its own engine of growth. After a crushing recession in 2015-16, growth is picking up and confidence has been boosted by the passage of a landmark pensions reform. Right now, a lot of investors — especially local ones — think Brazil is hitting a sweet spot.

One thing to pay close attention to is what some are calling a credit revolution, driven by low interest rates. The central bank’s policy rate is 4.5 per cent — a real rate of less than 1 per cent once inflation is taken into account. For savers and investors, this is a whole new world to which markets are still adjusting.

For decades, anyone with money in Brazil parked it in a bank for generous returns of more than 14 per cent a year — as recently as 2016. Low rates are now pushing them into riskier assets. This explains not only the surge in stocks but also the rapid growth of a market for corporate debt. Bond issuance has ballooned as companies, traditionally starved of credit from the banking sector — which still charges them interest rates of 20, 30 or 40 per cent — have been able to fund themselves by selling bonds with yields in single digits.

Emblematic of this is “the XP phenomenon”: the rise of XP Investimentos and other brokerages feeding the hunger of small investors for assets delivering something like the returns they are used to. XP went public on the Nasdaq exchange last month in one of the biggest market debuts of 2019. It is surfing the wave of the moment and investors have jumped on for the ride. Its shares are trading about 40 per cent above their listing price.

But there are reasons to be cautious. XP’s model is prone to upsets. Its investment banking arm structures bonds for novice issuers, which its fund management arm then sells to novice buyers. One R$1bn ($240m) bond blew up in November when its issuer filed for creditor protection, leaving 15,000 investors facing a wipeout.

There are longer-term risks, too. The idea of a credit revolution is based on the premise that low interest rates are here to stay. It is too early to be sure of that. Political surprises, especially under the current government, cannot be discounted. Nor is Brazil immune to external shocks.

For now, Brazil’s surging stock market is being driven by locals. Foreign investors, against the historic trend, have been big net sellers of São Paulo stocks for the past two years. Preliminary data suggest the pattern is continuing this month. Many remain to be convinced.

Quick Hits — What’s on the markets radar

The latest monthly read on US consumer price pressures revealed a soft outcome for December. Add that news with the retreat in wage growth for December payrolls, and it appears that Treasury yields and inflation expectations are showing signs of carving a top. True, the core measure of the consumer price index (steady at 2.3 per cent for the year to December) has been above the 2 per cent level since March of 2018. But there’s little sense of an acceleration brewing that in turn drags the Fed’s measure — core personal consumption expenditure price index — higher and spurs a shift towards a tighter policy stance.

Here’s the take from Oxford Economics:

“With economic growth slowing, an ongoing lack of corporate pricing power and global deflationary pressures exerting downward force, inflation is poised to remain quiescent in 2020.”

Of late, inflation expectations for five and 10 years via the Treasury bond market have bumped up against a ceiling of 1.7 per cent and 1.8 per cent, respectively. Inflation expectations were previously above these levels back during the summer, with the latest consumer price data also containing this downbeat development. Real average hourly earnings decelerated to a year-over-year pace of +0.6 per cent in December after running at +1.1 per cent the previous month. That marks the slowest pace for real earnings since August 2018.

Line chart of US breakeven inflation rates (%) showing Breakevens show signs of topping out

It likely caps the break-even trade for now, but as the Fed appears set to signal a preference for average-inflation targeting after its policy review concludes this summer, long-term buyers of inflation insurance should limit any dip in break-evens.

Liquidity always matters and in terms of bonds this is often highlighted by hefty orders for a new benchmark issue. Tuesday’s 10-year sale by Spain attracted a record €53bn in orders or bids, writes the FT’s Tommy Stubbington, for €10bn of new debt sold at a yield of roughly 0.5 per cent.

Here’s the thinking among bond investors or those with a mandate to own government paper:

“It’s quite difficult for investors these days to get bonds in large volumes, so a syndication like Spain’s is quite attractive,” said Rabobank strategist Lyn Graham-Taylor. “It’s an opportunity that might not come around again later in the year.”

The S&P 500 has risen some 400 points from early-October into record territory, led by a handful of tech titans as shown here via BCA Research, which makes the observation: “Currently, the top five stocks in the S&P 500 (AAPL, MSFT, GOOGL, AMZN & FB) comprise over 18 per cent of its market cap, even higher than the late-1999/early-2000 concentration.”

BCA sums up the current dilemma for investors:

“As a reminder, we are neutral the broad tech sector and overweight the largest subgroup, the S&P software index, thus participating in this euphoric rise in stocks that has been defying earnings fundamentals. While this can go on for a bit longer, it is clearly unsustainable and represents a big risk especially given the proliferation of passive funds.”

The latest Chinese trade data represent some promising news for the broader region, particularly for South Korea and Taiwan, argues TD Securities. The banknotes how imports from Malaysia, Philippines, Singapore, Taiwan and Thailand are up by more than 20 per cent for the year to December. Imports from South Korea rose the most, (+5.4 per cent over the past year) since October of 2018.

Your feedback

I’d love to hear from you. You can email me on michael.mackenzie@ft.com and follow me on Twitter at @michaellachlan.





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