In a somewhat light week for US data, investor attention was drawn abroad, particularly to China. As the world’s second largest economy, China commands serious attention from US investors as well as investors globally. Following the downbeat data release out of China on Monday and Federal Reserve meeting minutes release on Wednesday showing that several Fed Board Governors still hold an upward bias on interest rates, markets ended the week lower. The S&P 500 traded down by -2.1% and the US aggregate bond index fell by -0.5% in response to higher global policy rates. The downbeat market sentiment was partially offset by a strong US spending report on Tuesday that indicated the diverging fortunes of the US compared to China.
The US consumer continues to exhibit strength, and with over 70% of US GDP derived from consumption activity, continuing robust US retail sales is another data point helping the soft landing (no recession) narrative. On Tuesday, we got an extremely strong month-over-month retail sales report (+0.7% in July vs. +0.4% expected), with the “ex auto and gas” measure jumping +1.0% vs. an expectation for a +0.5% rise. The report even showed upward revisions for June. It is important to note that these numbers are not adjusted for inflation, but with inflation figures trending lower, real spending (incl. inflation) is still on the rise. The upbeat figures reflected increases across several discretionary sales categories, including sporting goods stores, clothing outlets, and restaurants/bars. While there may be pressure building on consumer finances (higher debt, lower saving rate), the spending habits of Americans show little signs of slowing supported by a strong labor market and rising wages. Too much strength, however, could force the Federal Reserve to pursue more aggressive policy should inflationary pressures prove sticky.
Meanwhile, in China, it appears few data points are trending in the right direction. A batch release of poor Chinese economic data late Monday night showed industrial production, retail sales, fixed asset investment, property investment and the surveyed jobless rate all came in worse than expectations. In conjunction with the bad data, the People’s Bank of China on Tuesday lowered the rate on its one-year loans—or medium-term lending facility—by 15 basis points to 2.5%, the steepest cut in three years, and the second cut since June. Bank loans plunged to a 14-year low last month while deflation is setting in and exports are contracting. The markets reacted poorly suggesting investors took this as a sign of more weakness to come.
It seems pretty clear that China is now in a recession, at least by Chinese standards. Even Chinese central bankers are suggesting stimulus measures that go directly to the consumer, an extraordinary step if enacted. In addition, after Tuesday’s interest-rate cut, the country’s stock exchanges asked several domestic investment funds to avoid being net sellers of equities, another extraordinary step that has not been widely used since the early days of the 2020 COVID pandemic. Beijing has recently tried to support real estate values and engineer a bullish stock market as a way to boost confidence, although it would seem those stimulus measures have failed so far. The onshore yuan sank toward its weakest in 16 years against the dollar as a worsening economic outlook and a widening interest-rate gap with the US weighed on sentiment.
In Chinese real estate, where more than 70% of household net worth comes from, values are falling again. New home prices fell (-0.2%) for a second straight month in July and have been lower for 18 of the past 24 months according to the 70-city new home price index provided by the National Bureau of Statistics. In addition, pressures are building in the secondary market where home prices slid -0.5%, a further sign of the deepening property crisis. Last month’s price decline was widespread, with 49 cities out of the 70 tracked by the government seeing new-home values drop from a month earlier, the most this year. In the existing-home market, where prices are less subject to government intervention, they fell in all but seven cities. Declining values across the country are putting Chinese developers at risk of default and increasing the probability of a possible financial contagion. Several of China’s largest property developers with trillions of outstanding debt (denominated in yuan) have missed payments in recent months. “The big danger is that a negative feedback loop kicks in, with property stress causing strains in the financial system, undermining credit expansion and depressing growth, which, in turn, exacerbates the slump in the property sector,” according to Bloomberg Economics. All signs point to more losses before structural issues can be addressed and remedied.
China is a critical input to the global supply chain and the sheer size of China’s economy can cause disruptions well beyond their borders. Treasury Secretary Janet Yellen called China’s economic weakness a “risk factor” for the US, but one that should not impact the optimism for the American economy. Yellen said she feels “very good about US prospects overall,” describing growth as healthy and the job market as strong amid a downward inflation trend. Secretary Yellen’s comments were published before the data release from China showing a bumpy recovery from the COVID pandemic.
Source: Bloomberg