"Strong" Shares Versus "Weak" Bonds, Central Bank Turns Hawkish
Key Points of the Report
Summarized below is our analysis under the Taihe Economic & Financial Outlook (June 2020) on the key global financial and economic events as well as global macroeconomic and financial market trends in May 2020:
1. The financial market presents a pattern of “strong stock market” and “weak bond market”. In foreign stock markets, the NASDAQ index of the U.S. hit a record high and even broke the 10,000-point mark. In domestic stock markets, the Growth Enterprise Index (GEI) broke the short-term ceiling and hit its highest point since April 2016. The logic behind the strength of the Chinese stock market differs from that for the U.S. one. The strength of A shares has strong fundamental support, while the strength of U.S. shares deviates considerably from the economic fundamentals, and there is a major risk of correction. Since May 2020, the Chinese bond market has experienced a significant correction, being extremely volatile, while the term spread has returned to its level in March. Whether it is based on the current economic fundamentals or direct demand corresponding to fiscal strength, there is no possibility of a rapid shift in monetary policy.
2. The “liquidity trap” is concerned in China. Under pressure from the pandemic, “loose credit” may fail to create credit. On the one hand, the structure of China’s financial supply has determined that there is little opportunity for credit creation that simply follows easy monetary policy, while on the other hand, the combination of weak demand and the impact of the pandemic has extended the time limit for “lost of credit”, thus affecting the development of the domestic economy in the long run. On the basis of China’s current financial structure, the dual impact of the pandemic and the weakness in demand has resulted in a high probability that money has been hoarded in the financial sector.
3. Review of the trends in China’s prices: overall, the main reason for CPI’s returning to the “2 era” in May 2020 is that food prices have stabilized and started to decline. A further decline in PPI growth is still hampered by weak demand and inventory problems. Notably, the impact of supply and demand on prices is often considered to be a short-term factor, and the decisive factor affecting the long-term trend of prices is the money supply. Given the negative impact of the pandemic and the continuous downturn in global markets, “loose credit” and monetary policies are highly likely to continue, so the growth rate of the money supply is likely to keep rising. Against the backdrop of ongoing structural deflation, monetary easing, and insufficient demand, the risk of monetary inflation being seamlessly linked to structural deflation needs to be addressed.
4. Review of the trends in China’s international trade: due to the pandemic, both global and domestic demands are dampened, and the inventory problems remain severe. Under this background, China’s exports and imports in the January-May 2020 period were affected to varying degrees, and export volume fell sharply in May 2020. If the pandemic among China’s trading partners is brought under control in the future, the “substitution effect” will be gradually eliminated, and it will still take some time for overseas market demand to rise again. If the pandemic in those countries is difficult to be controlled, the recovery in global demand will be slow, and the prolonged breakdown of the international supply chain will make China’s export increasingly difficult in the future.
5. Review of the trends in China’s investment: The size of the “new infrastructure” market has not yet been able to hold its own, and the investment in these emerging areas is nothing different than the investment-driven growth. In essence, these investments are made to stimulate economic growth. While investment in “new infrastructure” may cushion the blow in the short term against the backdrop of a sharp decline in GDP, in the long run, domestic and external demand may find it difficult to recover in such a short time. Also, if blind investment leads to accumulated debt burdens or other consequences, “new infrastructure” will suffer from related problems. To sum up, investing in new industries is viable, but should not be done blindly.
6. Review of the trends in European and U.S. manufacturing: Similar to the situation in the early stages of the pandemic in China, the impact of the pandemic in Europe and the U.S. is far from over, with manufacturing PMI of the Eurozone and the U.S. in May 2020 continuing below the threshold. However, unlike the recovery of China’s supply side, both the supply and demand sides of the PMI in Europe and the U.S. are sagging, and the economic recovery process is hard to get on track. In the context of a weakening demand in Europe and the U.S., the difficult process of resuming production and recovery, and the high risk of a secondary impact from the pandemic, both the supply and demand sides will place downward pressure on future manufacturing PMI.
7. Review of the trends in global trade: In the post-globalization era, the global trade chain has changed significantly under the impact of the pandemic. The status of leading import and export countries has changed quietly, and the traditional trade chain in the era of globalization has undergone considerable changes resulting from the pandemic. The mode of global trade will change from “an integrated industrial chain” to “a fully functional trade chain”. The return of industries and the reconstruction of regional industrial chains will change the global trade pattern of the past 30 years, and three significant changes will take place in global trade: first, the globalization of trade will gradually shift to the regionalization of trade; second, the layout of a single industry or a single industry chain will change to that of an integrated industrial chain; third, the focus of trade advantage will change from comparative advantage competition to comprehensive cost advantage competition.
8. Review of China’s monetary policy: China’s monetary policy continued to tighten marginally this month, and the open market operations and statements of the central bank have been hawkish. In the medium and long term, maintaining employment will be an actual “anchor for growth”. The recovery of domestic demand is slow and its sustainability still remains to be seen, while the situation of external demand is still not improving. Although the central bank does not provide liquidity protection in terms of fiscal policy, there is no foundation for a tight monetary policy in the post-pandemic era.
9. Review of the U.S. monetary policy: The risk that the Fed may face is the market’s over-expectations of easing policies, thereby the effectiveness of policy tools may have been consumed too early. For example, while the Fed has been reiterating that it will not consider negative interest rates for the time being, the interest rate futures market has already begun its preparation. The reason for trading the negative interest rate is that there is almost nothing left in the Fed’s toolbox except for options such as negative interest rate and yield curve control.
10. Review of the trends in China’s stock market: since May 2020, A shares and Hong Kong stocks have shown an upward trend amid volatile trading, but different sectors have responded differently. Among them, GEI rose above its high point this year and hit a four-year high, but the Shanghai Composite Index and Hang Seng Index are still lower than earlier this year. It is worth pointing out that the stock market gains in A shares and Hong Kong shares are comparatively moderate, with strong economic fundamentals to support them. With the reform of A shares and the gradual return of China Concepts Stock, a large number of excellent companies will emerge in A shares and Hong Kong stocks to absorb more private funds and foreign funds, thus creating a virtuous circle. Therefore, we are relatively optimistic about China’s stock market and believe that it is the right time to invest in A-shares and Hong Kong stocks.
11. Review of the trends in China’s bond market: in June, the yields of the domestic bond market continued to fluctuate upward against the backdrop that the central bank has turned “hawkish” and the economy has recovered marginally. After experiencing a marginal economic recovery and tightening policies, the yield of the national debt has returned to a reasonable range, and the phenomenon of idle funds has been rectified with the rise of short-term yields. In light of the global monetary easing, China’s central bank may not rush to tighten policy immediately, because an adverse monetary policy would not be conducive to the recovery of the exchange rate and the real economy. The current macro environment is not the same as that of 2016, and the economy is far from the point where a new round of supply-side reform is needed due to overheating.
12. Review of the trends in commodity market: in May 2020, domestic commodity prices rebounded across the board, the domestic economy continued to recover, and coupled with demand growth and some forward-leaning stimulus policies, industrial production was strong and economic data continued to exceed expectations. In terms of precious metals, gold and silver maintained a tight trading range from May to June, and against the backdrop of a strong rebound in risky assets such as U.S. stocks, gold’s hedging property had been suppressed, but due to the market’s optimistic expectations for recovery and the moderate rise of inflation expectations, real interest rates declined, and the demand for hedging such risk rose again. The long-term trade logic of precious metals remains unchanged. Regardless of the trend in risky assets, hedging demand and inflation expectations will continue to support the price of precious metals, so they will still have allocation value in the medium and long term.
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