Markets “Lulled To Sleep” Despite Big Trouble In Little China

Well, thank goodness for continued strength in crude and rising expectations for global fiscal stimulus because the data dump out of China overnight was pretty disheartening and in a rational world would have probably sparked a steep selloff. Instead Asian bourses were mostly green.

As for the data out of China, basically everything missed. Industrial production, fixed asset investment, retail sales, all of it. But more worrisome was the July new loan data. New yuan loans printed at just CNY464 billion, half of expectations. Here’s the breakdown:

(Table: Barclays)

Why does this matter? Well, remember that China is attempting to do the impossible: they need to deleverage and releverage at the same time. With economic growth decelerating, Beijing can’t really afford to choke off credit, but the country is sitting on a massive debt bubble. State owned enterprises need to be restructured and corporates in sectors suffering from overcapacity are likely to experience a nasty default cycle which quite clearly leaves China’s elephantine banking sector vulnerable to a sharp rise in sour loans. Here’s a look at the NPL trend (and bear in mind this is likely grossly understated):

(Chart: Deutsche Bank)

Meanwhile, authorities need to rein in shadow banking, but they know that by doing so, they’re effectively cutting off the last line of credit to the economy. So yeah, the new loan data is a critical piece of the puzzle when it comes to assessing what’s going on with the engine of global growth and trade. Here’s how Barclays summed it up:

“We think the nose-diving July monetary data partly reflect across-the-board weakness in FAI growth. The contraction in corporate loans is against the background of rapid slowdown in YTD private investment growth.  Although the government has been working on measures (reducing fees and relaxing barriers to market entry) to boost private investment since June, our view has been that the falling investment returns, elevated costs, financing difficulties and the “crowding out” effect from stimulus-boosted public investment pose continued headwinds. On the policy front, despite the materializing downside growth risks seen in the July activity data, we think the PBoC, on concerns of the potential housing bubble, rising financial leverage, as well as understated inflationary pressures, may continue to lean towards prudence. Therefore, while we continue to expect one rate cut and two RRR cuts, we continue to see risks remaining tilted to less broad-based monetary easing. The government is likely to lean towards using more targeted fiscal and quasi-fiscal measures, and infrastructure and public investment projects to support growth.”

Again, they need to ease but not too much. They need to deleverage the economy, but not too much. Like everything else in China right now, it’s a perilous balancing act.

But crude saved the day for Asian equities as oil is still riding high on yesterday’s Saudi jawboning. Here, have a look:

"Oil has been at the heart of the move, helping high yield credit spreads to narrow relative to U.S. treasuries and put real backbone behind the feel-good factor," Chris Weston, chief market strategist at spreatbettor IG told CNBC on Friday.

So a few zingers from Riyadh is all it takes, even in the face of a crumbling Chinese economy. Speaking of which, the IMF was out Friday warning that Chinese growth could decelerate further going forward, falling below 6% by 2020. Here’s one key passage from the Fund’s report:

“Directors highlighted the urgency of addressing the corporate debt problem through a comprehensive approach. They encouraged the authorities to harden budget constraints on SOEs; triage and restructure or liquidate over‑indebted firms; and recognize losses and share them among relevant parties, including the government if necessary.”

Basically they’re begging Beijing to deleverage before it’s too late. Here are the projections:

(Table: IMF)

As far as US markets go, the Fed got another excuse not to hike in September following weak productivity data out earlier this week as retail sales came in flat versus expectations of +0.4%. Predictably, Treasurys rallied:

Perhaps  Tom Siomades, head of Hartford Funds Investment Consulting Group said it best when he told Bloomberg the following: “What we’ve seen is not a preponderance of good news, it’s just been a lack of any real bad news. Today’s numbers missed across the board but where’s the reaction? People have been lulled to sleep here.”

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