Market Extra: Here’s why the global reflation trade can survive China’s credit slowdown

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Could a tightening of China’s lending spigots put an end to the global reflation trade in global stock markets this year as the world economy recovers from the coronavirus pandemic?

Though previous slowdowns in Chinese lending have sparked market volatility, some argue this time will be different as the U.S.’s fiscal largesse may be replacing China as the engine of global growth for the first time in two decades.

The International Monetary Fund predicted as much in its latest forecasts, estimating the U.S. economy to expand 6.4% in 2021.

In the past few months, investors have fretted that China’s efforts to iron out excesses and stabilize its financial system could hamstring the world recovery.

The “credit impulse”, which tracks lending growth as a share of GDP, has fallen below zero in recent months, after Beijing officials looked to curb lending to prevent any destabilizing excesses that might overheat China’s economy.

“You’re seeing a lot of interesting soundbites among policymakers in China,” said Michael Arno, associate portfolio manager at Brandywine Global. “There’s continued discussions around property market leverage. These are all signs that this is very coordinated in my view.”

Growth of outstanding total social financing (TSF), a broad measure of credit in the economy, slowed to 12.3% in March from 13.3% in February.

Arno says the credit impulse has historically tracked prices for iron ore and copper, and gauges of global manufacturing activity. However, recent supply shortages and electric car adoption have helped offset falling loan growth.

But the fiscal stimulus programs deployed by Western policymakers, led by the U.S., could be offsetting the impact of China’s credit pullback.

“China’s credit impulse started backing off earlier in 2020, and the rest of the big economies have now joined. This would normally be a worrying sign, but we don’t think it is now,” said Tamara Basic Vasiljev, a senior economist at Oxford Economics.

She noted the direct payments to households and businesses by the U.S. government are boosting savings in the private sector, “making credit less needed,” said Vasiljev.

Still, there’s plenty of investors who worry the sharp pullback in the credit growth of China’s commodity-hungry economy could hamstring global trade and manufacturing, even if the broader damage to the performance of risky assets was harder to ascertain.

“Depending on how you measure it, China is the largest economy in the world and its the largest trading partner of most emerging markets. What happens in China, matters greatly for other emerging markets,” said David Loevinger, an analyst at TCW Group.

See: Investors fear global markets vulnerable to China credit crunch

Friday served as a prime example of the sensitivity of investors to any signs of slowing growth in China.

After China’s official manufacturing purchasing managers index declined to 51.1 in April from 51.9 in March, global equities sagged.

China’s CSI 300 index
000300,
-0.79%

closed 0.8% down on Friday and the Europe’s Stoxx Europe 600 benchmark fell 0.3%. In the U.S., the S&P 500
SPX,
-0.69%

traded lower at the end of the week, albeit after closing at a record on Thursday.

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