With both commodities and Chinese stocks suffering sharp overnight drops, it is hardly surprising that today trading desks have quietly been sending out boxes full of xanax their best under-25 clients (those veterans who have seen one, maybe even two 1% market crashes), along with reports explaining just what China is and why it matters to the new generation of, well, traders. One such analysis, clearly geared to the Ritalin generation complete with 3 second attention spans, comes from Deutsche Bank which in a few hundred words seeks to explain the key risks threatening the world's most complex centrally-planned economy, and ground zero of the next financial crash.
Which, one day after our summary take on why the Chinese commodity, economic and financial crash is only just starting (as those who traded overnight may have noticed), is probably a good place to reiterate some of the more salient points.
As Deutsche Bank's Zhiwei Zhang writes in "Risks to watch in the next six months", the key thing to keep in mind about China now that the 19th Party Congress is in the rear-view mirror, is that the government is likely to tolerate slower growth in 2018. Han Wenxiu, the deputy head of the Research Office of the State Council, said that GDP growth at 6.3% in 2018-2020 would be sufficient to achieve the Party's 2020 growth target. And while this is a positive message for the long term, it indicates growth will likely slow in 2018. And, as DB warns, recent economic data suggest the economic cycle has indeed cooled down.
For all those seeking key Chinese inflection points, here are the three big red flags involving China's economy:
- For the first time since Q4 2004, fixed asset investment (FAI) growth turned negative in real terms in Q3 this year.
- Growth of property sales for the nation turned negative as well in October, the first time since 2015.
- The property market boom in Tier 3 cities is also losing momentum.
We hope not to have lost by now all the Millennial traders who started reading this post. To those who persevered, here - in addition to the risks facing the economy - are the other two main risks facing China's investors: (rising) inflation and (rising) interest rates.
Inflation. The benign headline CPI masks an important underlying trend. Nonfood inflation has been rising steadily – it reached 2.4% in Oct, an unusually high level compared to the historical average of 1.3%. This is largely driven by services prices, such as healthcare(7.2% yoy), education(2.8%), and domestic services(4.3%). Headline CPI inflation is expected to reach 3.1% by February 2018, with DB's baseline is that inflation will moderate in H2 2018, but watch out for the risk scenario that it will stay above 3% through the rest of 2018.
If inflation becomes persistently high, the central bank's hands will be tied, making any monetary loosening more unlikely, if not further tightening.
Interest rates. Interest rates are climbing around the globe, but more so in China than in the US.
Clearly it is not because of demand in the real economy, judging by weaker investment. One likely explanation is that financial deleveraging has caused NBFIs to reduce their (often leveraged) exposure to longer maturity assets. Inflation expectation may also play a role. If these are true, interest rates may face persistent upward pressure. This will in turn suppress borrowing: for example, LGFVs issue less bonds during periods of rising interest rates.
And while Deutsche's veteran Chinese analysts have some soothing words for the world's 25-year-old traders who have yet to see a bear market, and promise that nothing will break in China, we would disagree because as we have said for the past 3 years, the next global crisis will start in China, and with Xi's role cemented for the next 5 years (if not for life) the smart thing would be to have the Chinese economic hiccup (because recession is clearly a taboo under central planning) as soon as possible, so the economy can recover by 2022. Judging by the tremors in the past few days, he may agree.