Stimulus bets as China data looks shaky

We remain fixated on the events that will unfold on Thursday morning, with trading in the currency markets suggesting expectations of a change in language are a near certainty. 

Source: Bloomberg

However, near certain is not the same as a dead-set certainty; the strong run that the USD has had against a basket of currencies over the past 10 days reversed slightly overnight, suggesting the market is adding a buffer just in case the near certainty does not occur.

Thursday’s FOMC meeting remains the biggest hurdle to trade this week, and the mixed trading messages from overnight backs this claim. We expect no major trading activity for the next two days as there is too much risk being released in four hours come Thursday morning to take overly bullish or bearish positions.

What is growing as an Asian driver is stimulus bets from Beijing; there has been a sharp decline in economic activity in August. The data from Saturday showed the highest-weighted data in industrial production (IP) fell to 6.9% year-on-year versus estimates of 8.8% and a July print of 9%. What is even more interesting is month-on-month it contracted 2.3%.

Although most will point to monthly reads as being a small period and over-interpretation is a risk, negative IP moves like this are rare. China is a high trend growth economy, and even during the GFC it only experienced three negative month-on-month events. Since the GFC there has been one (April 2012), so make that two now, which illustrates the concern in the slowdown.

However, IP was not the only area to see sharp declines; fixed asset investment, retail sales and exports coupled with the fact that CPI and PPI both turned negative last week shows demand is in fact contracting, not growing as would be expected at this time of year.

The August slowdown is now stoking fears of downside risk to Q3 GDP; the Bloomberg tracking index, which measures industrial production, retail sales, passenger traffic, rail freight, investment and electoral production estimates that China’s Q3 GDP print could be 6.3%. This is leading the market to make the assumption that further stimulus will be released from Beijing; however we are not so sure of this.

Firstly, first-half GDP growth was 7.4% year-on-year which has giving the second half a buffer, along with the fact the central government is changing its methodology in calculating GDP. Most analysts believe this is likely to boost real GDP growth by 0.1 or 0.2 percentage points, making it easier to reach Beijing’s ‘around 7.5%’ target so it will still be able to claim its target was reached.

Secondly, Li Keqiang continues to resist calls for further monetary inputs as he looks to longer-term stability in the Chinese fiscal markets. He is very aware of concerns around China’s debt burden and the fact it needs to become self-sufficient and has stated clearly in the past month that he is not going to be caught up in short-term fluctuations.

However, the market’s reaction on the open of commodities futures yesterday suggests otherwise; rebar, Dalian iron ore futures and Shanghai copper all spiked higher, which translated into iron ore spot prices shooting up 3.9% and copper also adding value. It is nice to see a floor in iron ore, and the fall in the AUD over the past week will also help return some profitability to the high-end producers. However, I remain bearish in this space as fixed asset investment in China needs to turn before we see a sustained move in iron ore prices.  

Ahead of the Asian open

We’re currently calling the ASX 200 flat (suggesting it will add two points) to 5475. However, I reiterate that trading will be mixed until Thursday morning passes. One thing I have found interesting in trade over the last week is the sustained downward pressure on the yield trade. International investors look to be shedding out of the banks, US ten-year notes are becoming very attractive on a yield basis and profit and compressed yield in Aussie equities are being given up. Watch for further pressure here as the USD and US bonds see strength.

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