Back to the fourth quarter still to play
China’s economy may have already emerged from its cyclical low in the second quarter of 2022, but the road to recovery has not been easy. The summer heat wave led to power rationing in several major cities such as Chengdu and Chongqing, a booming economic zone with a population of 50 million. Meanwhile, however, retail sales, an indicator of overall consumption, maintained their healthy pace of growth, while auto sales were a pleasant surprise in August (passenger car sales grew in 28.9% year-on-year). This reinforced our long-standing assertion that the resilience of Chinese consumers is often underestimated. While supply chain disruptions eased following the reopening of Shanghai after a lockdown that lasted more than 60 days between March and June, China’s export boom was further bolstered by price effects. (global inflation) and improved logistics. These price effects were particularly evident in the surge in Chinese exports to certain economies (for example, exports to India increased by more than 50% year-on-year in June and July).
Meanwhile, the recovery faces three notable headwinds – 1) a struggling property sector; 2) the financial strains caused by the global tightening which have been gaining momentum lately; 3) the draconian policy of zero Covid.
Chart 1: Real estate investment has been declining since September 2021
Source: Wind turbine, Deloitte research
Graph 2: Pressure on the completion of building construction
Source: Wind turbine, Deloitte research
Housing sector data for August effectively extended the weak trends of previous months that began in September 2021. Falling home sales and investment levels added to bearish sentiment in offshore markets where bond yields of major developers such as Country Garden and Greentown hover around 30% and 10% respectively. Taken together, data on investment, land auctions and home sales suggest that weaknesses in the real estate market are likely to persist beyond the short term, meaning that the real estate sector is likely to dampen overall growth in the future. course of the next few years. The immediate political objective is to get developers to complete their projects and prevent the mortgage boycott from spreading further. A 200 billion RMB relief fund was set up in late August with a stated mandate to complete unfinished projects, but markets appear to have questioned its effectiveness. We are of the opinion that the government will not move away from its current position that “houses are for living in, not for speculation”, but the reality is that local governments cannot reduce their dependence on regard to land sales only in the medium term. Thus, even in the absence of a powerful stimulus to support the real estate sector, the policy mix should ultimately aim to prevent consumers from increasing their savings rate. Ideally, mortgage rates could be pushed down as developers get an incentive to complete their projects. For most Chinese consumers, they view real estate both in terms of consumption and investment. Banks will therefore have to sacrifice part of their profits by lowering interest rates in order to offer future owners more sweeteners. The question is to what extent commercial banks could reduce the cost of capital in a context of global monetary tightening. In our view, the PBOC could induce banks to lower mortgage rates further, say 100 basis points, but ultimately significant monetary easing could only be executed if the exchange rate is more flexible. On the latest development, major banks cut deposit rates on September 15 by 10 to 15 basis points, a preemptive measure to lower lending rates. China’s favorable balance of payments and relatively benign inflation allow the PBOC to deviate from Fed tightening, but the external environment matters. The message from Jackson Hole, where central bankers meet each year, was one of unambitious clarity: the big central banks such as the Fed and the ECB will have to continue their tightening crusade, even if it means that the real economy could suffer. The ECB’s latest decision to raise interest rates by 75 basis points, announced on September 8, confirmed this policy bias. The euro received a rare respite from the hawkish signal from the ECB and rallied above parity against the greenback, but extremely bullish sentiment towards the USD remains intact, as evidenced by a further drop in the yen (USD/JPY moved above 142, another 25-year high). If the dollar remains strong due to the Fed’s tightening campaign and ongoing difficulties in some emerging markets, more central banks will need to step up their monetary tightening efforts.
This is the case in Asia where most central banks will have to raise interest rates twice during the rest of 2022. Again, the two largest economies in the region, China and Japan, must restart their savings for different reasons. For Japan, as long as domestic inflation is under control, a weaker yen will do no harm. Unlike 25 years ago, China is the largest trading partner for most regional economies, and the rapid depreciation of the yen has had a relatively mild impact on regional currencies. The PBOC’s decision to guide USD/CNY close to 7.0, a psychological threshold, surprised the market but not us. Our USD/CNY forecast for 2022 of over 6.9 at the start of the year was based on China’s need to improve the effectiveness of monetary policy, not competitiveness. The question is whether China should adjust its exchange rate more significantly in sync with the competitive depreciation policies of other central banks (eg Korea). In our view, the PBOC is unlikely to replicate the BOJ’s stimulus strategy for stability reasons. Meanwhile, rising global interest rates could cause risky assets to underperform in most emerging economies until US interest rates peak. The upcoming FOMC meeting will present a severe test as investors remain unconvinced that the Fed’s drastic rate hikes could easily stop stubborn inflation.
The final challenge is Covid. Based on recent mobility data (passenger flows during the Mid-Autumn Festival were down 37.7% year-on-year), travel-related sectors have taken an additional hit as partial lockdowns have been implemented in many cities. The dynamic zero-Covid policy made a third quarter recovery more anemic than expected, but there will always be room to further optimize the current policy as we continue to learn how to better manage the virus. Assuming the lockdowns become more calibrated in the fourth quarter and the Fed enters its final tightening stages over the next two months, a recovery in the fourth quarter remains to be expected. As such, we maintain our original 2022 GDP forecast of 3.5% with an asterisk.