China's GDP growth over the first half of the year was probably overstated due to a frenzy of IPOs, bond issuance, and stock market volatility. The overstatement was a result of a financial sector growth surge anomaly this year, and not intentional manipulation. Although, Beijing was probably happy with the anomaly
Bottom line: Manufacturing remained weak in June. New orders are flat, hinting at a weak July. Employment PMI remains below 50, a worry for Beijing's primary economic policy goal of employment stability. But, services look much better in June, new orders in particular. Given my GDP trackers are running around 6.7% so far in Q2, the improved service PMIs hint at a modest improvement in June and a Q2 growth number around 6.7-6.8%. But, we will certainly need to see more data to increase our confidence in that number.
China's June manufacturing PMI was unchanged from May at 50.2, a weak but stable reading. New orders remained flat at 50.1. Employment came in below the 50 level, implying a contraction, at 48.
Services rebounded to 53.8 from 53.2, well above 50. Service new orders have bounced back to 51.3 The service numbers hint at a modest improvement in overall activity in June.
The PBOC cut key benchmark rates over the weekend by 0.25%. But, it is what they did not do that was important. The last few deposit rate cuts in this cycle included an increase in the allowable range around the benchmark deposit rate. The mandated ceiling on deposit rates remained unchanged with each cut. For that reason, the last few rate cuts were as much about laying the groundwork for deposit rate liberalization as they were about easing.
The rate cuts this weekend did not include an increase in the allowable range. So, the cuts were all about monetary easing this time.
Whether the stock market plunge was a consideration for the rate cuts is debatable. The cuts were made in tandem with targeted reserve changes to agricultural and small business lenders, which would imply that these measures were planned well ahead of the market plunge. But, the cut will have a positive effect on market sentiment regardless of whether that was the intention.
Real rates are still relatively high on a historic basis, implying that monetary policy remains too restrictive. Inflation, money supply, and growth are outside of targets, and the year is almost halfway done. The cuts were most likely a modest easing measure to nudge growth higher and indicators closer to targets and roll-back restrictive policies (see chart on the right).
A broad RRR in my view is still the most potent easing measure in the PBOC toolkit, but also the most dangerous for potentially fueling investment excesses. This rate cut is a possible sign that more potent RRR cuts are not imminent, and easing measures may be taken in more modest steps.
All in all, the cuts are good for sentiment and will provide modest help to sluggish investment growth, one of the main impediments to growth prospects. The cuts push back broad RRR easing prospects, but should improve Q4 prospects even more than I previously expected.
On the front end, China's property market continues to improve. Monthly prices rose 0.60% in May, based upon my GDP-weighted 70 city index. The rebounding house price numbers follow a May housing sales increase of 16.4% from last year. All-in-all, solid housing data in May.
Given the high estimates of unused inventory, it is difficult to know whether a rebound in the housing market can be sustained for an extended period of time. But for now, PBOC easing, the roll-back of mortgage restrictions, and the extreme relative housing price declines (disposable income is up over 8.5% and housing prices are down 3.2% over the last year) have given a boost to the market.
Weak construction continues to be a drag on growth. New housing starts are down over 12% from last year. But, I estimate that sales increases lead new starts by 6 months (see my posting "Some housing data the only good data in April's ugly economic release." ). That would put a construction rebound sometime in the Fall. Key commodities will see a surge in demand by the Fall as construction ramps up again after a long decline.
The first and second tier cities along the coast are leading price gains. These cities have significantly larger economies than central and western cities. So, the economic impact from these cities seeing a housing rebound will add more to growth than the central and western city property markets can detract. Here is the 70 city property price index visualized in a map:
China's May economic indicators point to activity equivalent to roughly 6.7% GDP growth over the month, according to my GDP tracker. The GDP tracker is up slightly from 6.6% in April. As we saw with the PMI numbers, activity has marginally improved on the whole, but a significant pick-up in growth is not yet in sight.
The property market, one of the largest economic headwinds over the last year, continues to show improvement. Residential property sales are up a blistering 16.4% over the last year after a boost from central bank easing, a roll-back of mortgage restrictions in March, and price declines. With disposable income up over 8.5% on the year and housing prices down over 4% over the same period, buyers have more enticement to enter the market. New housing starts are still soundly negative and construction is still declining. But, given the better sales and price moves, I still estimate a rebound in new housing starts and construction by around September or October. Housing sales usually lead construction starts by 6 months (see my post Some housing data the only good data in April's ugly economic release. for details). The outlook for iron ore and copper remain positive.
Consumption numbers are still very sluggish, with May's 1 year change in retail sales of 10.1% only modestly better than April's 10.0%. There is a negative correlation between retail sales and the stock market surge. Chinese consumers are potentially holding off on purchases in order to buy shares. Despite the creation of $6.6 trillion in paper wealth in the stock market over the last year, retail sales are plodding along at the slowest pace in decades. However, one interesting thing to note is the pace of online sales. So far this year online sales are up 39% from last year and now account for 9.5% of retail sales.
Investment and credit growth were still pretty weak in May, increasing 9.9% and 11.9% from last year respectively. Traditional bank lending has accelerated on RRR cuts, but that growth has been offset by an accelerated slowdown in other forms of credit, resulting in some of the slowest credit growth in decades. The weak investment will limit the potential for a meaningful pick-up in growth in the very short-term.
May industrial production grew at a slightly faster pace than April, but remains weak by historic standards. Many traditionally important sources of growth have declined over the last year: Auto production declined 1.8%, cement production declined over 5%, and crude steel was down 2.7% from last year's production levels.
All-in-all, Q2 looks to be growing at around 6.7% so far, lower than the 2015 target of 7%. Additionally, the May numbers don't give us any indication that more PBOC easing is imminent. Easing measures this year have already potentially unleashed trillions of RMB into the system and brought down interest rates considerably. So, the PBOC may wait until measures already introduced have had time to spread to the real economy before deciding to ease any further. If anymore broad easing takes place, I estimate that it will come around October.
I have created maps showing house price moves for the 70 cities in China's property price index. The map shows monthly, 1 year, and 5 year house price moves.
One main takeaway from the map is the distribution of cities seeing monthly price increases. Most cities seeing a price rebound are tier 1 cities on the coast, while many central and western cities are still experiencing price declines.
Here are the maps:
China's CPI rose 1.2% in May, modestly lower than the 1.5% rise in April. The core CPI number of 1.6% YoY is running a bit higher than the headline number, primarily on the fall in oil prices. May's other economic data has so far shown that growth is still very weak, and a bottom has potentially not been reached. The CPI data adds to the worry that economic activity remains subdued.
But, as I have mentioned before, PBOC easing measures will probably not translate into a growth rebound until sometime in the Summer. If we don't see any change in activity in the next few months, then we should start to worry. But for now, it will take time before easing leads to activity.
China's target inflation is around 3% for 2015. With nearly half of the year over with, this target is either totally unrealistic or Beijing is confident that its stimulus measures will be successful in increasing activity in the real economy.
I don't think that we should view the low inflation numbers as a sign that more PBOC stimulus is imminent. Easing measures this year have already potentially unleashed trillions of RMB into the system and brought down interest rates considerably. So, the PBOC may wait until measures already introduced have time to spread to the real economy before easing any further. Or, the PBOC may resort to newer tools for stimulating growth without stoking excesses (like we have potentially seen in the stock market rally), like the PSL (see my PBOC infographic for details).
China's trade data shows that the economy is still very weak. Exports declined 2.5% from last year, better than the decline of 6% in April, but still solidly below trend. Imports declined 17.6% from last year as industry and construction continue to slow. All-in-all, pretty bad numbers.
If you are waiting for a sign that growth is rebounding as a result of Beijing's stimulus measures, this data was not that sign. In fact, declining import demand shows that overall growth is still very weak.
If you are waiting for some data to hint at an improved global growth picture, China's May export data was also not a good sign.
Key points in China's trade numbers:
Some details:
I am building some more visually interactive data displays. I started with some maps that show the importance of China's demand for various economies.
There are a number of reasons for China's stock market surge over the last year: Central bank easing, investment flowing from the weak housing market into stocks, the accelerated opening of China's financial markets, flows from expectations of China shares being added to global indices.
But much of the surge seems disconnected from the real economy. How much? Below are some correlations between economic activity and share gains. Column one is the correlation of economic activity with stock returns from 2005 to mid-2014 for long-term reference. The second column is the correlation of activity with stock returns over the last year.
Over the last year, China's sizeable stock market gains have not boosted overall consumption via the wealth effect. However, jewelry and food/tobacco/bev consumption have been correlated with share gains over the last year. Total retail sales are negatively correlated with the market recently. Output from the industrial sector has also moved significantly out-of-step with stock market gains. China's PMI has been disconnected from stock market advances over the last year.
But, total loan growth is positively correlated with stock market gains.
So, many economic measures are totally disconnected from stocks, but loans and stocks are rising hand-in-hand. What effects China's stock market gains will have on the real economy seem unclear given the disconnect between the two.
The PBOC said it has disbursed 263 billion RMB ($42 billion) worth of pledged supplementary loans (PSL) so far this year to the end of May. For information on how the PSL program works, see my PBOC infographic. PSL activity should be viewed as targeted stimulus, not broad easing. The PSL activity this year has been used to support China's urbanization, according to the central bank.
263 billion RMB amounts to roughly 0.19% of total outstanding credit, and compares to 1.8 trillion RMB (if fully utilized) of easing from the two RRR cuts so far this year.
Through the PSL this year, specific banks have borrowed money against collateral at 3.1%, compared to 4.5% last year, reflecting the PBOC's efforts to bring down rates this year.
PSL activity this year will have little impact on overall growth and credit in comparison to other PBOC actions, but will be a modest positive for urbanization efforts and infrastructure spending.
The official manufacturing PMI came in at 50.2 for May, up very modestly from April's number of 50.1. Although a slight improvement on the month, as seen on the chart below it is not clear that we are seeing a significant pickup in activity. New orders PMI (50.6) does not show a clear pickup in activity either, although it has modestly improved as well. The numbers are a bit better than last month, but the dial has barely moved. It will still be a couple of months until the PBOC stimulus drives activity meaningfully higher. See my post "Things will get worse before they get better." for details. Employment PMI came in at 48 - below 50 - and probably no comfort to Beijing policymakers who ultimately want to keep employment stable.
The worrying number is the non-manufactuing PMI. At 53.2, non-many PMI is still above 50 and showing expansion. But, the direction and the speed of the slowing number needs monitoring. The service sector has been keeping GDP on target as the industrial sector slows below 7%. If non-manu PMI goes below 50, then GDP growth will have a hard time staying above 7% this year.
Here are all PMI component charts:
http://laohueconomics.com/charts/#/urban-avenue/
Iron ore inventories have fallen dramatically this year, in tandem with weak imports. Iron ore prices are up 22% from the low point in early April this year. This is promising data for the growth outlook, as well as the outlook for import demand in H2 2015. We expect construction to pick up in late Q3, which will add to the inventory drawdowns and import demand.
Housing prices are looking much better after significant declines over the last year. Housing sales rebounded in April. Those two data points where some of the only positive news in April's ugly economic numbers.
Construction and housing sales have been negative most of the last year after significant oversupply hit the market early in 2014. This is potentially good news for future growth prospects. Housing has been a huge drag on many sectors of the economy recently.
But, construction remains soundly in the negative. New construction is still declining, and we won't see a pick-up in heavy industry until construction rebounds.
So, if housing sales are indeed rebounding, how much longer until we see developers increasing construction activity? About 6 months is the historical time frame in which sales lead new construction, as seen in the chart below. Housing will probably be a drag on the economy until the Fall.
Important things to note about housing and why you should pay attention to it:
China's GDP probably grew at 6.6% in April, according to my GDP tracker. The service sector grew at 7.6%, and the industrial sector at 5.9%. Data was slow across the board, from production to consumption. This number will probably get worse before it gets better, due to the time lag between the RRR cut monetary stimulus and its lagged effect on a broad growth boost.
The industrial sector is still slowing significantly. Crude steel production is still declining, and electricity output weak, indicating that heavy industry is still one of the primary drags on broad growth. Construction related material production, like plate glass and cement, continues to decline.
Real retail sales were much slower than trend, indicating that household consumption was not spared in the broad slowdown. Services also weakened slightly according to my service sector GDP tracker.
Housing sales were just about the only good data point out of the April number release, growing at 7.6% YoY after some significant declines. This is possibly a result of the rolling back of housing restrictions, such as lowering the mortgage down payment requirements.
China’s GDP is widely expected to grow around 7% this year. But, 7% does not mean the same thing to all stakeholders. After decades of rapid growth in nearly all sectors in tandem, within China’s economy divergences are growing dramatically as Beijing reins-in some sectors and stimulates others to force restructuring.
China’s service sector and consumption continue to outpace the industrial sector. This is important to note, because China’s demand of goods and services from the outside world is dominated by commodities and industrial machinery (why would the world’s biggest maker of things need to import consumer goods from outside). See my trade info graphic for details on China's import composition. The effect of rebalancing on demand from the outside world will be asymmetrical. There are limited beneficiaries from a robust service sector and increased household consumption, but no shortage of China suppliers suffering a significant slowing of commodity and industrial machinery demand.
If you are concerned with negative China headlines roiling markets, then 7% might be the number you want to follow. If you are concerned with China’s growth rate on fundamentals of companies and countries outside of China that feed China's demand for raw materials and machinery, then a more granular analysis is required. 7% is not the number you want to watch.
For this purpose I have split my GDP tracker into two parts: services and the industrial sector. As you can see from the chart below the industrial sector has been weakening much faster than services. For most of China's suppliers, China’s growth might as well be closer to 6% (a significant drop from 14.5% five years ago), not 7%. If you are a coal or metals exporter, China’s growth might as well be negative or in the very low single digits, as most heavy industries have decelerated much faster than overall industry. If you supply the raw materials for China's construction market (almost half or China's iron ore demand is used for construction), then demand will continue to decline until we see a pickup in new starts.
As consumption driving reforms unfold and the service sector continues to outpace industry the divergence will grow. It is probable that the industrial sector slows to the a rate in the low 5%s over the next year or two, as the overall GDP number moderates only slightly from its current 7% pace. And as mentioned, that low 5% growth rate will be the effective of growth for most of China's suppliers.
Trade numbers were in the negative YoY in April. Much of the export decline can be explained by a strong currency vs. trade partners, as Beijing has refrained from weakening the CNY to boost competitiveness. The CNY was up roughly 19% vs. the EUR and 15% vs. the JPY over the last year, feeding through to the declines in exports. We should expect to see weak exports for months to come, which will be a drag on overall growth prospects this year.
Imports, one of the best gauges of short-term activity outlooks, declined significantly, -16% from last year. Much of this is a result of commodity price declines, but after accounting for price declines the underlying import number is probably somewhere around -7-8% on the year.
Commodity exporting countries continue to feel the brunt of China's import demand weakness. This will continue until Beijing's fiscal and monetary stimulus reach the broad economy, and/or the housing market turns back to the positive.
My import and commodity demand forecasts are still hinting at continued declines over the next few months.
Commodity imports on a volume basis:
Soybeans -18% YoY, iron ore -4% YoY, copper -5% YoY, crude oil up 9% YoY.
Last month Beijing intervened in the stock market and in doing so added to the list another market to support - along with property, credit, and the CNY (see my posting China stock market interventions are a setback to reforms.). As China's shares went into free fall, Beijing had to step in to maintain its credibility. The result has been the biggest monetary boost of the year. The broad RRR was cut 0.50%, potentially unleashing $100 billion into the market for lending, and the lending and deposit rates were cut 0.25%. Beijing has stopped its targeted easing and unconventional stimulus in favor of a broad traditional cut in rates and RRR. Its has unloaded its biggest guns to shore up confidence.
With the cuts came the long awaited liberalization of China's deposit rates. Historically, China controlled the rates banks could pay depositors. The overnight actions by the PBOC removes some this control, giving the market sway over the majority of bank rates in the economy. The move was probably a concession to reformers. Banks will still have political pressure from Beijing when setting rates, but the move will allow more competition in banking.
As mentioned in earlier blogs entries, PBOC easing cycles historically see at least three reserve cuts each cycle. Many, including myself, expected the cuts to come later in the year, but the stock market declines forced the PBOC to move those cuts forward.
The easing measures have stopped the global market sell off, and should provide some modest support for growth. But, as mentioned in past blog entries, monetary easing measures have been offset by Beijing's reining in of shadow banking and cleaning up of local debt (see my blog post Reflation Troubles.) These measures will probably do more for growth later in the year, and have a lower impact than monetary boosts in past years.
The primary growth boost we will see this year - from both fiscal spending that has been slow in arriving and a property market rebound - will arrive this Fall.
Overall, the cuts have been good for stopping the global sell-off, but we should be cautious in forecasting what the cuts will mean for the real economy. In the near-term, after intervening a second time and putting its credibility on the line again, Beijing will be stuck supporting the markets for some time.
