Decent momentum into Q1:20

Promisingly, China’s monthly macroeconomic figures imply that economic momentum loss has been suspended. In both November and December, the economy posted positive signs of recovery. Growth in industrial production rebounded, consumption remained firm, fixed asset investment stabilized – buoyed by public sector projects – and real estate resilience remains despite authorities remaining tight on financing. In addition, producer prices seem to be heading out of deflation, trade numbers are looking better, and credit data has eked out small gains.

Specifically:

• Industrial production rose from 5.6% y/y YTD in November, to 5.7% y/y YTD in December, well above the low point of 4.7% y/y YTD in October.
• Retail sales expanded at the same speed as last month, rising by 8.0% y/y YTD in December.  
• Fixed asset investment (FAI) accelerated from 5.2% y/y YTD in November, to 5.4% y/y YTD.  

Previously:

• Producer prices contracted by 0.5% y/y – better than the1.4% contraction in November; consumer prices increased by 4.5% y/y in December – unchanged from November.
• PMI for manufacturing remained unchanged at 50.2 in December, and services held up reasonably well, slipping from 54.4 in November, to 53.5 in December.
• Exports accelerated from -1.3% y/y in November to 7.3% y/y in December; imports accelerated from 0.7% y/y in November, to15.7% y/y in December. 
• Also, total credit growth accelerated a fraction, rising from 10.67% y/y in November, to 10.69% y/y as banks loans expanded at 12.5% y/y - basically the same as November).

Overall, then, the Chinese economy expanded by 6.0% in Q4:19, and has good momentum heading into Q1:20. Even though we still aren’t quite convinced the economy has genuinely bottomed out, the data is better than envisioned and certainly much improved since October. Our inhouse China Activity Index confirms this; only slipping fractionally in August, then improving from 5.80% in October to 6.27% in November and 6.47% in December – the highest level since March 2019.

China’s economic growth is still likely to drop below 6% next year though for the first time since 1990. That's down from 6.1% in 2019 and 6.6% in 2018, marking a third straight annual slowdown. Also, of course, GDP growth could fall as low as 5.4% in a worst-case scenario where trade talks with the US break down again.

Conversely, the inking of Phase One of the trade deal will boost sentiment. That is a positive for the global economy and financial markets. Nevertheless, the balance of probability tilts towards a further breakdown in relations rather than a genuine resolution. Indeed, China has committed to purchase an additional USD200bn in goods and services from the US by the end of 2021 – an increase of 100% y/y in 2019 and 45% y/y in 2021. In return, China hasn’t really been given much, apart from the US side has pledging to reduce its 15% tariffs on USD 120 billion worth of Chinese goods to 7.5% and suspend plans for other tariffs. Resentment will likely build fast. Meanwhile, the more difficult issues have yet to be addressed, and there seems to be no space for China to make any concessions regarding the remaining (and far larger) issues. What the deal does give China is time, temporarily stabilizing the relationship, pre-empt any further actions against Chinese firms, and remove some pressure on the economy.

Still, China's near-term trajectory will be determined by policy choices. So far, China’s cyclical slowdown has been driven primarily by domestic forces and policy priorities – specifically tight financial conditions, de-risking the financial sector, weak local government investment and soft domestic demand. Even though total credit growth also accelerated for the second consecutive month in December, it only increased by a fraction – from 10.67% y/y in November to 10.69% y/y in December. The relatively weak credit impulse means that if the economy has stabilized, the growth recovery will likely be muted and perhaps short-lived. And, just like last year, the Financial Stability and Development Commission (FSDC), the People’s Bank of China (PBoC), and China Banking and Insurance Regulator (CBIRC) have made it clear already that they would press on with the de-risking campaign, defusing financial risks, improve and expand the scope of its macro-prudential regulation, further dismantle the shadow banking industry, prevent real-estate speculation, and work with local governments to reform state-owned enterprises and clear hidden debt.

All of this implies that the currency is no longer on the back foot. Recall, capital outflows were already building back up towards 2015/2016 levels. However, the better-than-envisioned macro picture – albeit one that is unconvincing and could be short-lived – and a less tense external environment, combined with a still prudent monetary policy tilt, imply that the currency is likely to strengthen versus the USD from 6.89 currently, to around 6.75 by the end of Q1:20. 

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