By
Evan Schnidman
:
It is an exciting time to be a macro analyst. Equity markets are
clearly not driven by fundamentals. Rather, they are driven by
hopes and misunderstanding of central bank policies. Hopes of
stimulative policies drive rallies, and failure to implement them
causes sell-offs. In fact, central banks are driving policy so much
right now that a downward revision in growth and inflation in China
prompted a rally based on hopes of stimulative market intervention
by the People's Bank of China.
Confusing Policy Implications
The People's Bank is probably the most confusing central bank in
the world because Chinese politics is remarkably opaque due to a
cloistered inner circle of decision makers. Confounding matters is
the fact that the People's Bank essentially targets growth the way
many central banks target inflation. Growth is an outcome variable,
so it is much further downstream than inflation, and it includes
significantly more inputs beyond the control of central bank
policy. Nevertheless, the People's Bank does have a huge impact on
the Chinese economy.
Today, China announced that its economic growth had slowed
considerably, and that inflation has gone from over 6% a year ago
to down around 2%. This is a rapid drop in inflation that indicates
growth may be slowing much faster than previously projected. This
reduction in growth and precipitous drop in inflation leaves the
door wide open for Chinese economic stimulus. Never mind the fact
that reduced growth in China is still in the 7 percent range (at
least three times that of the U.S.). That does not meet Chinese
expectations and desires for widespread industrialization. So, the
market reacted by assuming the Chinese central bank will step in
with some form of stimulus.
Since China has experienced solid growth throughout the crisis
and recession, its stimulus could still be a simple reduction in
interest rates. This would satisfy investors seeking more liquidity
in Asian markets, but it could reignite fears of a weak Chinese
currency in relation to the U.S. dollar. Sure, this keeps Chinese
goods cheap for U.S. consumers, but it also makes U.S. goods more
expensive for Chinese consumers (and comparatively, U.S. goods
would be pricier than Chinese made goods for consumers around the
world as well). This means that significant action to loosen
monetary conditions in China could harm U.S. exports and halt our
meager manufacturing recovery in its tracks.
Conclusion
We now live in a paradoxical world where slowing growth is a
good indicator for markets because they assume central bank
intervention. So, markets saw weaker Chinese growth and slowing
inflation as a sign of an impending stimulative intervention by the
People's Bank of China. The trouble is that the markets seem to
forget the currency and trade implications of central bank actions.
Should we actually see the People's Bank intervene in China, it
could be a very bad sign for the U.S. manufacturing and labor
markets,
Disclosure:
I have no positions in any stocks mentioned, and no plans to
initiate any positions within the next 72 hours.
See also
S&P 500 Rally - Important Negative Divergences
To Notice
on seekingalpha.com