Doug Noland: China Credit and Global Inflationary Dynamics

Liquidity will tend to further inflate the already inflating asset class(s); “hot money” will chase the hottest speculative Bubble. Inflationary surges in Credit growth can, as well, have profoundly different impacts depending on inflationary expectations, economic structure and the nature of financial flows.


February 14 – Bloomberg: “China added more credit last month than the equivalent of Swedish or Polish economic output, revving up growth and supporting prices but also fueling concerns about the sustainability of such a spree. Aggregate financing, the broadest measure of new credit, climbed to a record 3.74 trillion yuan ($545bn) in January… New yuan loans rose to a one-year high of 2.03 trillion yuan, less than the 2.44 trillion yuan estimate. The credit surge highlights the challenges facing Chinese policy makers as they seek to balance ensuring steady growth with curbing excess leverage in the financial system.”

Like so many things in The World of Finance, we’re all numb to Chinese Credit data: Broad Credit growth expanded a record $545 billion in the month of January, about a quarter above estimates. Amazingly, last month’s Chinese Credit bonanza exceeded even January 2016’s epic Credit onslaught by 8%. Moreover, as Bloomberg noted, “The main categories of shadow finance all increased significantly. Bankers acceptances — a bank-backed guarantee for future payment — soared to 613.1 billion yuan from 158.9 billion yuan the prior month.”

February 14 – Bloomberg: “China’s shadow banking is back in full swing. Off-balance sheet lending surged by a record 1.2 trillion yuan ($175bn) last month… Efforts by the People’s Bank of China to curb fresh lending may have prompted banks to book some loan transactions as shadow credit, according to Sanford C. Bernstein.”

Yet this was no one-month wonder. China’s aggregate Credit (excluding the government sector) expanded a record $1.05 TN over the past three months, led by a resurgence in “shadow” lending. According to Bloomberg data, China’s shadow finance expanded $350 over the past three months (Nov. through Jan.), up three-fold from the comparable year ago period.

Friday from Bloomberg: “White House Chaos Doesn’t Bother the Stock Market.” Many are confounded by stock market resilience in the face of Washington discord. Perhaps it’s because global liquidity and price dynamics are currently dictated by China, the BOJ and the ECB – rather than Washington and New York. Eurozone and Japanese QE operations continue to add about $150bn of new liquidity each month. Meanwhile, Chinese Credit growth has accelerated from last year’s record $3.0 TN (plus) annual expansion.

February 14 – Bloomberg (Malcolm Scott and Christopher Anstey): “Forget about Donald Trump. The global reflation trade may have another driver that proves to be more durable: China’s rebounding factory prices. The producer price index has staged a 10 percentage-point turnaround in the past 10 months, posting for January a 6.9% jump from a year earlier. Though much of that reflects a rebound in commodity prices including iron ore and oil, China’s economic stabilization and its efforts to shutter surplus capacity are also having an impact.”

China’s January PPI index posted a stronger-than-expected 6.9% y-o-y increase. A year ago – back in January 2016 – y-o-y producer price inflation was a negative 5.3%.  It’s worth noting that China’s y-o-y PPI bottomed in December 2015 at negative 5.9%, the greatest downward price pressure since 2009. In contrast, last month’s y-o-y PPI jump was the strongest since August 2011 (7.3%). China’s remarkable one-year inflationary turnaround was not isolated in producer prices. China’s 2.5% January (y-o-y) CPI increase was up from the year ago 1.8%, matching the peak in 2014.

There are two contrasting analyses of China’s record January Credit growth. The consensus view holds that Chinese officials basically control Credit growth, and a big January confirms that Beijing will ensure/tolerate the ongoing rapid Credit expansion required to meet its 6.5% 2017 growth target (and hold Bubble collapse at bay). This is viewed as constructive for the global reflation view, constructive for global growth and constructive for global risk markets. Chinese tightening measures remain the timid “lean against the wind” variety, measures that at this point pose minimal overall risk to Chinese financial and economic booms.

An opposing view, one I adhere to, questions whether Chinese officials are really on top of extraordinary happenings throughout Chinese finance, let alone in control of system Credit expansion. Years of explosive growth in Credit, institutions and myriad types of instruments and financial intermediation have created what I suspect is a regulatory nightmare. I seriously doubt that PBOC officials take comfort from $1.0 TN of non-government Credit growth over just the past three months.

Indeed, I suspect authorities will be compelled to ratchet up tightening measures. Not only is timid ineffective in the face of rampant monetary inflation. It actually works to promote only greater excesses and resulting maladjustment. I would argue that Chinese officials today face a more daunting task of containing mounting financial leverage and imbalances than just a few months ago. The clock continues to tick, with rising odds that Beijing will be forced to take the types of forceful measures that risk an accident.

Inflationary biases evolve significantly over time. For example, QE in one market environment can have profoundly different inflationary effects than in a different backdrop. Liquidity will tend to further inflate the already inflating asset class(s); “hot money” will chase the hottest speculative Bubble. Inflationary surges in Credit growth can, as well, have profoundly different impacts depending on inflationary expectations, economic structure and the nature of financial flows.

I strongly contend that a more than one-half Trillion ($) one-month Chinese Credit expansion in early 2017 will exert divergent inflationary impacts to those from early 2016. Why? Because of distinct differences in respective inflationary backdrops. This time last year, disinflationary pressures were demonstrating powerful momentum. The Chinese economic slowdown was gathering force, the financial system was under mounting stress, funds were fleeing the country, and fear was overwhelming greed. Compared to this time last year, crude prices are today about a third higher. Importantly, last year’s massive Credit expansion upended disinflationary forces.

Today’s inflationary backdrop offers a notable contrast: the inflationary path of least resistance is now higher. This argues that Credit excesses will exert a more robust impact on inflationary biases throughout the Chinese economy – inflationary forces that have achieved powerful self-reinforcing momentum. Furthermore, official efforts to restrict financial outflows add a further dimension to the analysis. Not only do I expect this year’s Credit to exhibit more potent effects, it is also likely that tighter regulations ensure less finance leaks out of the system through international flows. In short, unprecedented quantities of new “money” and Credit will in 2017 further inflate a Chinese economic system already terribly maladjusted by years of unprecedented monetary excess.

Already this year, Emerging Market equities (EEM) have posted double-digit gains (10.1%). Stocks in Brazil and Argentina are up 12.5% and 16.3%. Indian stocks have risen 6.9%. Too be sure, the incredible Chinese Credit boom is playing a major role in fueling strengthening inflationary biases throughout developing markets and economies.

February 15 – Bloomberg (Sho Chandra): “Forget wondering when U.S. inflation will reach the Federal Reserve’s goal. It may be there already. The biggest monthly jump in almost four years in the Labor Department’s consumer-price index led some analysts to raise their estimates… for the Fed’s preferred inflation gauge, the Commerce Department’s personal consumption expenditures price index. Morgan Stanley’s Ted Wieseman and Michelle Girard of NatWest Markets both said that the PCE measure probably rose 2% in January from a year earlier, up from previous projections of 1.8%. Economists at Goldman Sachs gave an estimate of 1.98%.”

Here at home, January CPI rose 2.5% y-o-y, the strongest gain since early 2012 (core CPI up 2.3% y-o-y). After drifting around zero for much of 2014, y-o-y CPI increased to 1.4% by January 2016. Anyone doubting that global inflationary dynamics have evolved from a year ago should examine a few CPI charts.

Talk one year ago was of indomitable global deflationary forces. The ECB and BOJ stepped up with major QE expansions, while the Fed put rate normalization on hold after a single little baby step. Central bank buying coupled with already over-liquefied markets spurred a historic collapse in global bond yields. After beginning the year at 62 bps, a melt-up in bund prices saw yields sink to below zero by June (on the way to negative 19bps). Italian yields dropped from 1.59% to 1.04%. Spanish yields fell from 1.77% to 0.88%, while French yields dropped from 0.99% to 0.10%. Yields in the UK sank from 1.96% to 0.52%. Japanese yields dropped from 0.26% to negative 0.29%. After beginning 2016 at 2.25%, ten-year Treasury yields were down to 1.36% near mid-year. Too much “money” (speculative and otherwise) chasing too few bonds.

There are now apparently ample quantities of bonds for global buyers. With inflation dynamics pointing to rising general price levels, “risk free” sovereign bonds are no longer the securities of choice. Importantly, ongoing QE has ensured that markets have become only more over-liquefied. These days, however, it’s much more a case of “too much ‘money’ chasing too few equities and corporate debt instruments”

Highly speculative sovereign debt markets dislocated back in 2016. It was the type of speculative blow-off and derivative-related melt-up that previously would have ended in tears (along with bloody havoc). So far, ongoing QE and near-zero rates have ensured a most orderly of major market reversals. At the same time, the monetary backdrop has guaranteed that speculative melt-up dynamics have turned their sights on equities, corporate debt and EM. Global markets are today being dictated by extraordinary monetary and speculative dynamics. Trump policy proclamations provide convenient market justification and rationalization.

It is a prevailing 2017 theme that global markets are extraordinarily vulnerable to an unexpected change in the monetary backdrop. Count me just as skeptical of the current equities surge as I was of last year’s surging bond markets. In my mind, the 2017 bull story for equities is as dubious as last year’s deflation histrionics – rationalization for a surge in bond prices driven more by a powerful global market dislocation than underlying fundamentals.

I’m not necessarily arguing that we’ve commenced a sustainable surge in consumer price inflation. An accident in China, Europe or Japan (to name only the most obvious), and the world could sink right back into the disinflationary muck. At least in the short-term, the upward momentum in inflationary pressures could be enough to sway central bank decision making. So long as CPI trends were pointing downward, it was easy to rationalize the positive case for QE. CPI pointing upward around the globe just might have central bankers thinking twice about QE infinity. For a number of years now, market operators have slept soundly at night knowing any meaningful “Risk Off” (de-risking/de-leveraging) would be countered with yet another batch of QE.

Yellen took on a relatively more hawkish tone this week. The March 15 FOMC meeting is now in play for a rate rise, while an increasing number of analysts are now forecasting three increases during 2017. The ECB will clearly face heightened pressure to wind down QE. And even BOJ chief Kuroda this week made uncharacteristically cautious comments with respect to the risks of monetary stimulus. But in the short-term, I’ll look to Beijing for perhaps the most intriguing monetary developments. And there is support for the view that recent equity gains have been fueled by market dislocation dynamics, the type of advance that would leave risk assets especially vulnerable to a changing monetary backdrop.

February 16 – Wall Street Journal (Chris Dieterich and Gunjan Banerji): “It is the buzz of Wall Street: a five-day, 15% plunge in a U.S. mutual fund whose bearish bets were undone by the S&P 500’s latest run to fresh records. The decline of Catalyst Hedged Futures Strategy fund, a $3.4 billion fund employing complex derivatives, is topic du jour on trading desks fixated on the surprising resilience of the postelection U.S. stock rally and the long decline of volatility, or price swings. Many investors have been surprised by the S&P 500’s 9.7% run-up following the Nov. 8 election… The Catalyst fund typically uses options positions in a configuration that seeks to maximize gains from stable or gently rising markets, or else shield investors from sudden declines.”


Original Post 18 February 2017

Categories: Doug Noland, Perspectives