The global economy has continued to expand at well above its trend growth rate since the beginning of 2017, but there have been some early signs of a slackening in recent weeks. According to the latest monthly results from the Fulcrum nowcasts (attached here), global growth is now running at 4.1 per cent (at PPP exchange rates), which is about half a percentage point lower than a month ago.
This “slowdown”, which has been driven by the US and China, is well within the normal range of monthly fluctuations in the global nowcast, and it may be nothing more than a temporary blip. There are some legitimate reasons for concern about the slowdown in China, which seems to be connected to tighter credit polices. Fortunately, however, the Chinese economy seems in better shape to absorb this tightening than it was in 2013-15.
Since the American Presidential election in November 2016, much of the attention of investors has been focused on the US economy, which is usually seen as the litmus test for the “global reflation theme”. The nowcasts have identified a strong surge in US growth, starting in September 2016 and peaking at over 4 per cent in March 2017.
Although the 2017 Q1 official GDP data showed an annualised growth rate of only 0.7 per cent, it is clear that the problem of “residual seasonality” in the data has emerged again this year, and the Federal Reserve has commented that the slowdown will prove “transitory”. GDP growth in 2017 Q2 is widely predicted to approach 4 per cent – close to our recent nowcasts – as seasonal issues correct themselves in the official data.
Admittedly, the US nowcast has weakened in April, though it still stands at 3.2 per cent, compared to a trend growth rate of 2.1 per cent. It is too early to say whether this deceleration represents anything very significant. The nowcast models anticipated a gradual return towards trend growth in coming months, though the drop in April has been slightly larger than statistically expected. The chances of a self-sustaining break-out to above trend growth without additional policy support may have diminished, but should not be entirely written off yet.
Offsetting these doubts about the strength of US growth, the nowcasts for the Eurozone economies have continued to move higher across the board. The bloc as a whole is now estimated to be growing at just under 3 per cent, the best results for several years. In the advanced economies as a whole, activity growth is estimated to be running at 2.7 per cent, compared to a trend rate of 1.7 per cent [1].
Despite the widespread focus on the US economy, the recovery in global growth since the low point was reached in March 2016 has mainly come from elsewhere (see table). According to the nowcasts, the global growth rate has risen by 1.91 percentage points since then, and only 0.26 points of that overall improvement has come from the US. The rest has come mainly from the emerging economies, which have contributed 1.30 points of the total gain.
Within the emerging economies, the Chinese contribution of 0.44 points stemmed from an unexpected acceleration to above-target growth in the second half of last year, aided by a substantial injection from public investment, a 10 per cent depreciation in the real exchange rate, and the lagged effects of a huge surge in credit growth.
However, it seems that activity growth in China has now lost some momentum:
The Chinese Credit Cycle
Until recently, the overwhelming consensus among investors has been that the Chinese authorities would not tolerate any serious interruption in GDP growth until after the leadership transition in the 19th Party Congress in November. Furthermore, compared to the slowdown in 2013-15, external demand, private investment and the housing market seem in better shape to withstand any tightening in credit policy.
This comfortable belief has now been challenged by weaker activity data, and by signs that the authorities are more worried about excessive credit growth than had earlier seemed likely. Last week, these concerns were a major factor behind the sharp declines in commodity prices, which had been expected to firm as global growth accelerated this year. Chinese equity prices have also dropped by almost 6 per cent in the past month.
The current bout of tightening started in December. Since then, maturity mismatches, extended rollover risks and opaque collateral arrangements have caused periodic bouts of severe stress in the overnight SHIBOR market.
The authorities have so far been able to address bankruptcy risks during these episodes by directing liquidity from the regulated large banks towards the unregulated entities that have been experiencing liquidity problems. Nevertheless, the tightening has caused significant increases in short and long term interest rates, reversing the declines in rates seen during the period of aggressive monetary easing in 2015/16:
This monetary and regulatory tightening is having the desired effect on broad credit growth, which has fallen from an annual rate of 25 per cent in early 2016 to only 15 per cent now, as the shadow banking and wealth management sectors have been squeezed:
Does this represent a major shift in the policy regime? Recent nervervousness has been exacerbated by reports that President Xi Jinping has called for greater “financial security”, repeating the concerns about excessive leverage expressed by an “authoritative person” (probably the President himself) a year ago. The fear, expressed strongly by the IMF in its Global Financial Stability Report, is that total credit in the economy is already at levels that have always caused financial crises in other economies, and delay will only make the eventual deleveraging more difficult.
The authorities’ objective seems to be to rein in surging leverage in the shadow banking sector through a combination of tougher regulation and tighter liquidity provision to that sector, without causing wider systemic risks to the financial sector. They also hope to be able to squeeze the growth of credit between financial entities without restricting credit provision for legitimate economic expansion.
This is not the first time that the PBOC has attempted to slow down the growth of credit by a combination of tighter liquidity and more stringent regulation of financial institutions and this latest episode will probably mean that the period of unexpectedly strong Chinese activity growth, which started in 2016 Q1, is now over. This may take some of the buoyancy out of the global reflation theme for a while, especially if tighter regulation of Chinese wealth management products reduces the speculative demand for commodities.
In the past, however, China has not been willing to persist with credit tightening whenever it started to threaten the GDP growth target, which is currently set at 6.5 per cent for 2017. That still seems to be their strategy – at least until after the People’s Congress in November.