One week after we reported that Beijing had capitulating, urging "Local Govts To Unleash Debt Flood As Cities Begin Backstopping Property Developers" this was confirmed overnight when Goldman reported that the latest Politburo meeting and RRR cut indicated that indeed China's policymakers have focused on stabilizing growth by shifting to an easing mode. This is consistent with Goldman's below consensus expectations as its 4.8% real GDP forecast for next year has already embedded moderately easier domestic macro policy in 2022 vs. 2021. Given the latest policy signals, the bank expects another RRR cut in Q1 next year. But although the 1-year LPR rate may drop 5bp on the back of the July and December RRR cuts, Goldman still does not expect policy rates (OMO and MLF) to change. Finally, while the recent dovish signals have reduced left-tail risk to next year's GDP growth, continued property market turmoils including the technical default of Evergrande remain the key to watch in the coming months.
Here are the key points from China's long-overdue dovish relent which will spark a huge surge in China's credit impulse:
- Policy news after the 6th Plenum in early November have been dovish (Exhibit 1). Most importantly, the December Politburo meeting put emphasis on supporting the property market and stabilizing growth amidst the significant slowdown in housing activity and considerably below-trend growth year-to-date (<3% annualized rate vs. 5-6% potential growth). For example, the word “stability” (稳) appeared 9 times in this year’s Politburo meeting readout vs. 3 times last year. The word “housing” (房) appeared 5 times this year vs. only 1 time last year. “Anti-monopoly" (反垄断) and "preventing disorderly expansion of capital" (防止资本无序扩张), which made appearance in last year's December Politburo meeting, are no longer included this year. While the broader directions of “housing is for living in, not for speculation” and improving regulatory frameworks are unlikely to change, with the PBOC announcing RRR cut and State Council meeting stating accelerating local government special bond issuance, domestic macro policy has clearly shifted to an easing mode.
- Such developments are largely in line with Goldman's expectations: in China, policies had been very tight this year, and for growth to reach close to 5% next year they need to loosen noticeably. Without policy easing and if the extremely weak housing activities persist through next year, growth would be even lower than Goldman's below-consensus forecast. Recent events are reassuring that policy easing is indeed happening. To be clear, Goldman's China economists do not expect the type of easing seen in 2015/16 or early 2020. The latest policy signals also suggest policymakers do not want to risk over-stimulating the economy. For example, in the statement explaining the RRR cut, PBOC reiterated “no flooding the market with liquidity” and the "prudent" monetary policy stance has not changed.
- Goldman expects another RRR cut in Q1. The RRR cut announcement on last Friday (Dec 3) was somewhat surprising to Goldman which notes that as recently as mid-October, PBOC was signaling its preference for using OMO, MLF and structural tools such as relending programs to provide liquidity as opposed to RRR cuts. Even the Q3 Monetary Policy Report released on November 20th included a box explaining why excess reserves were low for technical reasons and should not be over-interpreted. Recent events serve as a reminder that PBOC operates in a broader institutional framework and State Council guidance has primacy. Both the July and the December RRR cut are likely related to policymakers’ concerns over the Evergrande debt crisis and broader property sector contraction. Which is why Goldman now agrees with what we have been saying all along, and it expects another RRR cut in Q1, which implies a total of 3 after the July and December cuts. This is on the lower end of the historical precedents: the 2015/16 downturn saw 5 rounds of RRR cuts in total. We may see fewer RRR cuts this time around because (1) policymakers appear to be in the “do just enough” mentality in managing the balance between cyclical growth and structural reforms, and (2) robust FX inflows are indirectly feeding domestic market with liquidity, in contrast to for example 2015 when FX flows were draining liquidity. Q1 is the likely timing, in our view, because (1) it precedes the first Fed hike in June that consensus now expects, (2) it tends to see high liquidity demand seasonally, (3) PPI inflation is likely to have moved down from the current double-digit year-over-year growth by then, and (4) large amounts of developer USD bonds are coming due in January and March which may cause elevated uncertainty and risks in the financial market.
- 1-year LPR rate may drop 5bp, but we do not expect policy rate cut (absent a major economic crash). According to the PBOC, the July and December RRR cuts reduce bank costs by RMB 28bn combined. This is enough to reduce 1-year LPR rate by 5bp. At the same time, Goldman does not expect the 5-year LPR rate or policy rates such as OMO and MLF rates to change. The reasons are twofold. First, cutting the 5-year LPR would reduce mortgage rates and send a strong signal on property market easing, which policymakers would not want to convey to the market. Second, cutting policy rates would have a broad impact on the economy whereas policymakers still emphasize “precision” and “prudent” in their description of macro policy in the December Politburo meeting.
- Reduced left-tail risk to growths forecast with property market key to watch. Taken together, China policy has clearly shifted to an easing mode while ex-China seems to be on a tightening path. All else equal, Goldman argues that such a divergence could weaken the CNY on the grounds of narrowing interest rate differentials. But given how much CNY has appreciated both against the USD and on a trade-weighted basis (around 10% since mid-2020), policymakers may welcome a slower pace of CNY appreciation. With the December Politburo meeting, which was chaired by President Xi himself, sending dovish signals, left-tail risk to the 4.8% real GDP forecast has notably reduced. That said, there are still two-sided risks to baseline expectations. For example, materially more easing measures such as policy rate cuts, would generate upside risk. On the other hand, risk would skew to the downside if the property market does not stabilize and improve sequentially in the coming months.