Pressure Mounts on China to Act

Global CIO Commentary by Scott Minerd

More bad news out of Asia: Chinese manufacturing conditions are back at the same levels as they were at the height of the financial crisis in 2009, a clear sign that China’s economy is slowing.

The preliminary Caixin China purchasing managers’ index (PMI) fell to a 77-month low of 47.1 in August, down from July’s final reading of 47.8. Any index reading below 50 represents a contraction. The data had an immediate effect on local markets—the Shanghai Composite Index dropped 4.3 percent to its lowest level since July 8—and China’s fragility will do nothing to shore up confidence in global markets.

We all know the dramatic steps that were necessary to revive the Chinese economy in 2009—a 4 trillion renminbi (RMB) stimulus package, equivalent to about 12 percent of China’s annual gross domestic product (GDP) at the time. China will need to take drastic action again, and to a greater degree than it has done in recent weeks.

The challenge is that attempts by the People’s Bank of China (PBoC) to inject liquidity are being sterilized by offsetting sales of reserve assets to stem a more dramatic slide in the exchange value of the RMB. This limits the impact of actions to increase monetary liquidity as is evidenced by the recent unintended rise in short-term rates in China.

As a result, the PBoC will soon be forced to reduce bank reserve requirements while allowing for a more rapid devaluation of the RMB. Time is not on the side of Chinese policymakers. Given the severity of the current domestic slowdown, pressure is mounting for more radical policy action.

Expect to see further downward pressure on commodity prices, global equities, and U.S. Treasury yields. The first sign that we are approaching a bottom for all three will be when China caves and allows the RMB to adjust to a more appropriate level, which could mean another 25–30 percent decline in the value of the RMB against the U.S. dollar.

Things will get worse before they get better, and investors around the world are demonstrating appropriate concern. Unfortunately, relief is nowhere in sight.

Economic Data Releases

Housing Data Is Positive; Inflation Remains Subdued

• Existing home sales were better than expected in July, up 2.0 percent to 5.59 million homes. Sales have risen for three consecutive months.
• Housing starts inched up in the July reading by 0.2 percent, up to 1.206 million, a nearly eight-year high.
• Following a strong run up in prior months, building permits plunged 16.3 percent in July, the largest drop since 1981.
• Initial unemployment claims rose by 4,000 for the week ending Aug. 15, up to 277,000.
• The index of leading indicators fell 0.2 in July, the first decline in five months. The decline was almost entirely due to plummeting building permits.
• The consumer price index (CPI) rose 0.1 percent from June to July, less than forecast. The year-over-year rate ticked up to 0.2 percent, with core prices remaining up 1.8 percent from a year ago.

Mixed Signals in Europe; China Manufacturing Worsens

• The euro zone manufacturing PMI was unchanged in the preliminary August reading, holding at 52.4.
• The euro zone services PMI beat expectations in the initial August reading, rising to 54.3 from 54.0.
• Consumer confidence in the euro zone rose slightly in August, up to -6.8 from -7.0, the first increase since March.
• Germany’s manufacturing PMI showed a solid pickup in activity in August, up to a 16-month high of 53.2. The services PMI fell slightly from 53.8 to 53.6.
• Germany’s GfK consumer confidence index fell to a six-month low of 9.9 in the September reading.
• The manufacturing PMI in France remained in contraction in August, worsening to a four-month low of 48.6. The services PMI fell from 52.0 to 51.8.
• U.K. retail sales ticked up 0.1 percent in July following a decline of the same magnitude. Sales excluding fuel were up 0.4 percent.
• China’s Caixin manufacturing PMI sunk to 47.1 in August, the lowest since 2009.
• Japanese exports rose 7.6 percent from a year ago in July, while the trade deficit widened.

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