As Chinese Credit Plummets US Stocks Soar On Hopes Of More PBOC Easing; But Is Conventional Wisdom Again Wrong?

For those who are perplexed why today stocks soared despite a renewed battery of horrendous economic results, the answer lies in China, where overnight the PBOC reported that July aggregate credit creation (aka Total Social Financing), at least the "as reported" variety, plunged by the most ever, and instead of growing at the expected RMB1.5 trillion, it registered a monthly change of only RMB273 billion, or a miss to expectations of over 80%, and a complete collapse from the CNY1,974 billion reported in June.


The monthly "change in the change" amounted to just over RMB1.7 trillion, the biggest drop in history.


Aside from the TSF, new loans in July also plunged to RMB385 billion from RMB1079 billion in June.


The breakdown of actual TSF components is as follows, per BofA:

  • New loans fell sharply to RMB385bn in July from RMB1,079bn in June, driven by a decline in new corporate short-term loans. The hefty RMB345bn in new corporate short-term loans in June was perhaps due to a response by banks to the government’s call for supporting growth as well as the need to meet mid-year regulatory requirements on deposits.
  • Both entrusted and trust loans declined in July, perhaps due to tighter regulation on interbank business. New entrusted loans decreased to RMB122bn from RMB272bn, while new trust loans contracted by RMB16bn from a net increase of RMB120bn in June.
  • New corporate bonds declined to RMB143bn in July from RMB261bn in June, in part reflecting a temporary shortage of liquidity on resumed IPOs. However, we notice the issuance of LGFV bonds decreased to RMB77bn from a monthly average of RMB237bn in 2Q. The trend of slower issuance of LGFV bonds echoed our long-held view that the central government should leverage up (via PSL for instance) rather than build up local government indebtedness. We expect local governments will get a large amount of funding from the China Development Bank which in turn will get funding from the PBoC’s PSL scheme in the second half of this year.
  • Non-discounted bankers acceptance (BA) decreased by RMB416bn in July, after increasing by RMB144bn in June. However, BA is notoriously volatile and the data are of low quality.
  • FX loans contracted by RMB17bn in July after rising by RMB36bn in June, although sentiment of stronger CNY/USD returned last month.

As for the new loan components:

  • New medium-to-long-term (MLT) corporate loans moderated to RMB208bn in July, compared to RMB269bn in June, suggesting some moderation in loan demand for fixed asset investment projects.
  • New short-term corporate loans declined by RMB236bn in July, sharply down from the RMB354bn increase in June, mainly driven by seasonal factors as new short-term corporate loans surged in June. Meanwhile, new discounted bills jumped to RMB173bn in July from to RMB78bn.
  • New MLT loans to households (mainly mortgage loans) moderated to RMB180bn in July from RMB199bn in June. This number is still relatively robust compared to the monthly average of RMB188bn in 2013. There have been some local news reports of banks reintroducing discounts to the benchmark lending rate in bigger cities and shortening of mortgage release time. Meanwhile, new short-term loans to households dropped to RMB26bn in July from RMB158bn in June.

Furthermore, while M0-M2 also came in well below consensus, it was RMB deposits which crashed by RMB1980bn in July, versus a 3790bn increase in June, indicating a major change in what until recently had been a virtually diagonal data series.

So what happened? As BofA notes, "with such a shock in money and credit data in July, markets’ first response is that there has either been a sudden credit tightening, intended or unintended, or a sudden drop in credit demand. However, based on all government policy talks and all policy benchmarks including interbank rates, we see no such intention or action on credit tightening at all. Instead, the government repeatedly emphasized delivering stable economic growth by maintaining its existing monetary policy stance. On the other hand, most leading and coincident indicators point to stable, if not improving, aggregate demand in July." 

BofA's take is that there is nothing to worry about:

"Our conclusion is that the big fluctuations in loans, deposits and TSF were just  consequences of the outdated monetary statistics which are heavily distorted by unique regulations, financial innovations and some recent new accounting rules related to shadow banking.

We believe that monetary policy has not been tightened, underlying credit growth is actually quite stable, new loans and TSF could see a large rebound in August, and headline money and credit growth are likely to jump in August. In anticipation of the market impact, the PBoC made a public explanation post the July data release with messages broadly in line with our views. The PBoC in particular mentioned that entering into August, new loans averaged between 30bn to 50bn per day, which supports our belief that new loans could jump to RMB700bn - RMB1.0tn and TSF could be back to above RMB1.0tn in August."

The PBOC provided its own explanation:

The PBoC believes credit and aggregate financing growth is still in a reasonable range after adjusting for seasonal factors, irregular issues and base  effects. The PBoC said in its statement that China’s daily new RMB loans were RMB30-50bn in early August, suggesting robust (normalized) credit growth in August. The jump in deposits in June and subsequent decline in July resulted from seasonal factors, which in turn led to the rise and fall of loans (note the CBRC does a serious mid-year assessment with a focus on loan to deposit ratio, forcing banks to ramp up deposits at the end of June). The fluctuation was widened by the rapid growth in bank wealth management (WMPs) and internet-based money market funds. IPOs in July also diluted some deposits, which in turn constrained growth in bank loans and other types of credit such as entrusted loans and bonds. In addition, growth of non-standard financing was curbed by new regulations introduced and financial institutions strengthening their risk control. The PBoC did see some impact from the demand side. With the economy facing downward pressure and corrections in the property market, effective loan demand is not as strong as before. Banks are more cautious in granting loans to some high risk regions and sectors.

Others, such as Bloomberg's Tom Orlik were far less sanguine:

  • China central bank’s comments on sliding credit and financing may exacerbate rather than calm unease, Bloomberg economists Tom Orlik and Fielding Chen write.
  • The "precipitous" 1.7t yuan ($276b) drop in aggregate financing is largest on record, suggesting more than just seasonal factors at work; PBOC said drop was seasonal
  • Weak loan demand and property downturn, which PBOC used to explain data, not reassuring
  • PBOC says seasonal slide in deposits was a constraint on lending, but the record drop of 1.9t yuan in savings shows massive volatility in deposit base, thus not a positive development
  • Rising non-performing loans, which PBOC said have made banks cautious about lending, is a negative sign for growth
  • Higher risk in shadow banking, another factor highlighted by PBOC to explain slowing credit growth, is also negative should rising defaults push banking sector into cautious contraction
  • Drop in July credit may not be immediately repeated as preliminary data for the first two weeks of August suggests total for month may be close to 800b yuan, more than double July’s total; rapid rebound probably result of govt guidance rather than change in underlying conditions; PBOC may come under  increasing pressure to move away from targeted stimulus to cutting interest rate

And therein lies the rub: because conventional wisdom, now so habituated to getting all the cheap credit it can get, did not anticipate such a dramatic collapse in Chinese credit last month, is eagerly expecting a proportional response from the PBOC, one which would potentially involve significant easing, which is precisely what US equities priced in today when they closed near the highs of the day, even as there was not a single piece of good macroeconomic news overnight.

Pretty cut and dry right? Well not really. Recall that as we reported in the last week of July something odd was revealed: namely that China quietly unveiled and implemented its Pledge Supplementary Lending line, or as it is increasingly better known: China's QE. What we said:

Shortly after we exposed the real liquidity crisis facing Chinese banks recently (when no repo occurred and money market rates surged), China (very quietly) announced CNY 1 trillion of 'Pledged Supplementary Lending' (PSL) by the PBOC to China Development Bank. This first use of the facility "smacks of quantitative easing" according to StanChart's Stephen Green, noting it is "deliberate and significant expansion of the PBOC's balance sheet via creating bank reserves/cash" and likens the exercise to the UK's Funding For Lending scheme. BofA is less convinced of the PBOC's quantitative loosening, suggesting it is more like a targeted line of credit (focused on lowering the costs of funding) and arguing with a record "asset" creation by Chinese banks in Q1 does China really need standalone QE?

Of course, this would explain much: not only the collapse in conventional credit creation, and its replacement with direct - and quite stealthy - QE from the PBOC, leading to a displacement of inside money with outside, which also would explain the surge in the Chinese stock market in August as PBOC QE was pumped directly into equities a la the US QE mechanism in which excess reserves are used as collateral against purchases of risk-on futures and other marginable derivative contracts.

It also would mean that completely opposite to expectations, the PBOC will not step in to boost credit creation in China further, which in turn served to stimulatte US risk, but quite the contrary - it won't do a thing, as it already is actively engaging in QE, i.e., conventional wisdom is wrong again.

Alas, the answer of what is really happening in China's mysterious, opaque, "make it up as we go along" banking system will never be known so at least one can speculate at will...


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