Caution on China Exposure As Credit Is Starting to Dry Up

china credit impulse 070517

When the RBA decided earlier this week to hold fire on gunning for a gradual rise in interest rate expectations, surely it was considering this: China credit impulse with a 9 month lead is taking a dive.

In other words, very recent mothers-to-be shall be giving birth to their children in a notably worse Chinese economy than when said children were conceived. How much worse? Perhaps four PMI points worse, which implies GDP growth falling by about 1-1.2% from the current annual growth rate of 6.9%. This doesn’t imply a market crash but it does imply that fewer Australian businesses need to boost investment.

We like leading indicators at Assist FX — both quantitative and qualitative. While the future is always uncertain, analyzing it as accurately as possible is best accomplished with forward looking indicators and models. What we are seeing on the horizon in China is a controlled, modest deleveraging with a minor tail risk of accelerated bankruptcies. As the facts change, so will our models. For now, we remain cautious on China-sensitive financial instruments such as the Australian dollar.

Soft RBA Tone and Quiet China Liquidity Drain to Constrain AUD

The Reserve Bank of Australia expressed more caution than market participants expected in its monetary policy statement this morning.

The nuanced hawkish rhetoric shift by other advanced economy central banks recently, particularly from the RBA’s key commodity producer counterpart in the west, the Bank of Canada, was not imitated by RBA Governor Lowe. It was a highly balanced statement with several risk factors included, rather than including just a few boilerplate risks as could have been the case with less accommodative intentions.

Here are the policy statement highlights courtesy of Reuters (bolding is mine):

  • Indicators of labour demand remain mixed
  • Employment growth has been stronger over recent months
  • Some signs housing market starting to cool
  • Housing debt has outpaced slow growth in incomes
  • House prices rising briskly in some markets
  • Supervisory measures should help address debt risks
  • Various forward-looking indicators point to employment growth going forward
  • Rising A$ would complicate economic adjustment
  • Economic outlook supported by low rates
  • Wage growth remains low, likely to continue for a while yet
  • Inflation expected to increase gradually as the economy strengthens
  • Slow growth in real wages is restraining growth in household consumption
  • Business conditions, investment have picked up
  • Economic growth expected to strengthen gradually
  • Broad-based pick-up in global economy continuing

Why the caution? I believe the RBA is factoring in reduced Chinese liquidity into its forward looking models as China looks to reduce some froth out of its shadow banking sector. The PBOC has refrained from injecting liquidity via open market operations for eight consecutive days. This is already negatively impacting equity prices in Shanghai and will dampen near term demand for Australian exports as Chinese financing dries up.

AUDUSD is likely to see continued weakness into .7525 support. Rather than jumping on the AUDUSD selling bandwagon it is preferable to sell rallies against CAD and NZD.