China smelling of roses?
One of our themes over the past few years has been to pay more attention to China when trying to predict the future market environment and less to the USA. That’s not just because the Chinese economy is now 70% the size of the US (compared to just 11% in 1997) and its central bank’s balance sheet is 1/3 bigger than the Federal Reserve. China has also been extending its hegemony across the world in many ways, from its Belt and Road infrastructure vision across western Asia to its policy of encouraging use of the yuan rather than the US$ for global trade contracts.
The contrast between the monetary policies of the two countries is particularly stark right now. The Federal Reserve, followed by most ‘western’ nations, is running very tight policy, whereas the People’s Bank of China and most Emerging Markets (EM) are relatively loose. In data terms, provided by our friends at CrossBorder Capital Limited as at 30th September, the DM index is at 6.5 (range 0-100) whereas the EM is at 54.7.
For markets this has a strong implication that the US$ is likely to strengthen against the Chinese yuan, because other things being equal central bank easing equates to more supply. We’d expect the Japanese yen to move somewhere in between the two, as another long-held thesis of ours is that Japan’s orbit is now at least as much influenced by China as America.
It is also a much more positive background for EM. Many commentators assume that the strong US$ will continue to be a negative for them, but we’d comment that yuan weakness will be a just as large, if not larger, positive for them (and incidentally Japan). We also note that crossborder flows into EM have rebounded sharply since the low point in June 2018, suggesting greater confidence than newspapers would lead readers to believe.
Given the dire liquidity background just now, we continue to expect a more substantial correction in markets than we saw last week. If China continues its current loose monetary policy, those countries connected to it economically may just come out smelling of roses, at least in market performance terms.
To learn more about CrossBorder’s research on liquidity please click here.