The source of genuine fundamental improvements in the Chinese economy can only come from the manufacturing sector… At least this is the opinion of Chinese investors who bought stocks and ditched fixed-income securities during the last episode of rising manufacturing PMI:
Let me remind you that on March 29, the markets were updated with the closely-tracked China manufacturing PMI, which unexpectedly jumped into positive territory (above 50 points), markedly outstripping the estimate. In one of my previous articles, we explored that the magnitude of the PMI rebound is of less importance than the variation of rise, depending on the size of firms. The greatest increase in activity was observed in small enterprises most vulnerable to demand shocks and credit conditions:
This is a very promising shift in terms of the outlook for corporate optimism as its more volatile and sensitive to economic changes in small firms.
It’s also important that two key sub-indexes shifted to recovery: production volumes and new orders (a leading indicator).
The government linked the positive changes in production with the success of the targeted credit measures for enterprises that bolstered consumption and investment. Well, the episode of liquidity injection into the economy, to the tune of 4.6 trillion Yuan in January is not quite a targeted measure. However, in February the PBOC tried to move monetary aggregates back to normal, but yet again returned to expansion in March:
Given the size and position of the Chinese economy in the world, it’s easy to understand what’s now driving the global appetite for risky assets. Reliance stems from the PBOC’s assistance, with its sheer scale obviously supporting domestic production data.
The growth of divergence in the economic surprises of US and China is probably the direct result of the difference in the magnitude of monetary easing. More precisely, the Fed kind of took a break concerning this:
Data released on Wednesday indicated that the impulse in PMI developed in broad macroeconomic variables. Industrial production and retail sales exceeded expectations, while the government’s target variable – GDP, rose by 6.4% in the first quarter, compared with a forecast of 6.3%. At first sight, the forecast looks good, however it’s possible that the “impatient” PBOC is just waiting for the first signs of improvement in order to tighten control of the monetary supply.
Further to this, the first signs of a U-turn in monetary policy are already in full view. For example:
- The widely expected decline in RRR in April was not realized.
- The PBOC did not conduct open market operations for 18 days in a row.
- The new medium-term lending facility decreased in size. As a result, overnight repo rates soared to a maximum of 4 years, indicating growing liquidity deficit.
It’s clear that, with the transition of the People’s Bank of China to a more offensive stance, the stock market will again be under pressure. Additionally, if the growth of Chinese economy again turns out to be not “self-sustained”, then new economic shocks overlapping the tightening policy may hit the asset prices much more painfully.
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