By Kevin Muir of the Macro Tourist
Although I understand the China bears’ argument, I am not nearly as pessimistic
Many traders are getting their knickers in a knot about yesterday’s Chinese downgrade by Moody’s. Suddenly, the Kyle Bass Chinese implosion scenario is on everyone’s lips.
The downgrade has fanned the flames that were already burning from the recent sell off in Chinese centric commodities.
There can be no doubt China has been suffering from a reduction in liquidity. Over the past few months, the Chinese bond market has imploded. The 5 year yield has risen from 2.4% last Fall, to 3.7% last week.
Sure looks ugly. No wonder everyone is jumping on the Kyle Bass bandwagon.
I have been waiting to write this piece. Sitting on the sidelines, watching the China sell off continue. Biding my time until the right moment presented itself.
Although I understand the China bears’ argument, I am not nearly as pessimistic. Do I think there are some massive credit problems in China? For sure. But where I differ from my ursine colleagues is that I anticipate a global inflationary papering over of these problems. Yes, I understand that it’s not quite so easy to snap your fingers and create inflation without causing distortions in the currency and other financial markets. Yet over the past few years, I have watched Central Bank after Central Bank pull out a big stack of blue tickets at the slightest sign of problems. Why anyone expects this to stop is beyond me.
The Federal Reserve’s tightening cycle is making it more difficult for China to ease. But I wonder if the Chinese orchestrated this recent slowdown to a greater degree than most market participants guess.
Now skeptics will claim the market moved against the Chinese and they are losing control. And although I concede over the long run the market sets the price, over the short run (and for that matter, the medium run as well), governments (or Central Banks) can greatly influence market prices. And nowhere is this more true than China. The Chinese government’s ability to quickly implement economic or monetary policies is much greater than any other developed country.
The recent China slowdown was, therefore, most likely planned, or at least accepted by the Chinese authorities. The China bears will argue it was forced on them, and they are scrambling to patch the leaking ship. And maybe they are right. Maybe this is the start of the big China unwind.
Yet I think there is another explanation.
This Fall the Chinese government will hold the 19th National Congress of the Communist Party. There are no elections in China, but this shin-ding is equally important.
At this gathering, the leaders of the Chinese Communist Party are chosen. Although Party General Secretary Xi Jinping’s job is secure, there are important decisions to be made that will determine if he continues on for one or two terms.
Now if you were a government leader, and facing what amounts to a re-election this Fall, what would you do? Would you let the economy run hot this spring and potentially be faced with an overheating problem that would require you to withdraw liquidity at the very moment you were holding your meeting?
Or would you tighten the preceding Winter and Spring, so that you could ease into Autumn’s meeting, ensuring the economy was improving while your fate is being decided?
It’s pretty clear that a tightening-so-you-can-ease-later is the way to go.
So while everyone gets all bothered about the recent Chinese slowdown, I see it as an expected pause.
But even more importantly, since when do traders think it is a good idea to sell on the news of a downgrade?
Seriously? Credit rating downgrades are often the signals that all the news is baked in. It’s like when your Grandmother phones you up and asks if she should buy bitcoin. You know the move is over.
Remember early last year when oil was imploding and all those energy and mining companies went no bid? The selling was relentless and not only did the equity portion of the cap structure get hammered, but the devastation in the corporate bond market of these companies was epic.
I remember trading FreePort-McMorRan bonds. They were in free fall, and the bids had completely disappeared. Five year bonds broke 50 cents on the dollar. And into this collapse, the credit rating companies wandered in with some helpful advice. Yup, you guessed it. They downgraded FCX. And I will let you guess what happened from there.
And before you complain that this is different, it is a country, these jokers get those downgrades wrong all the time as well.
Remember January 19th, 2016? Well, on that day, the IMF downgraded their global growth forecast. At the time, I speculated that it might not be a good idea to follow their advice (An Uptick in Growth in 2016?).
Well, once again, the authorities’ warnings proved to be close to the bottom.
The fact that Moody’s downgraded China should not be reason for the bears to celebrate. And when you combine it with my belief that China will prime the pump to ensure the economy will be humming this Fall when the Chinese Congress meets, I suspect we have hit a short term low in the China bear trade.
After all, look at a longer term chart of the ANZ Bank China commodity chart:
No doubt we have paused, but on a longer term basis it looks like we have bottomed, and the trend is higher.
I know it’s not what the cool kids are doing, but count me in the camp that believes this is not the start of the China unraveling, and if anything, the decline offers a decent buying opportunity.