So what is your view on the dollar?
The Federal Reserve is concerned about the global economy and, more specifically, about the possibility that further US interest rate increases will stoke market turmoil once again. This isn’t motivated by altruism – economic and market ructions in the rest of the world could easily derail a US recovery. That’s why the Fed struck a particularly dovish tone last month, when rates were left unchanged, despite the strength of recent unemployment and inflation data. Growth and inflation expectations were moderated and the Fed’s own forecasts suggest two hikes this year, down from the four they were signalling in December. A rate-rise in June is still on the table, but the bar to delivering one is perhaps a little higher than before. This has tempered expectations of dollar strength for the time being. That said, our Asian Fixed Income colleagues do expect further rate hikes (hence dollar strength) as the US labour market continues to tighten and core inflation picks up.
Investors don’t seem so pessimistic about China these days. Why?
Equity markets in mainland China appear to have stabilised for the time being, a welcome respite from the steep declines at the start of the year. Investor sentiment seems to have been bolstered by Premier Li Keqiang’s confident tone at last month’s close of the National People’s Congress – a carefully stage-managed event at which China parades its leaders before the world. Li stated that the country would achieve its economic targets, supported by various policy tools to stimulate growth, while reiterating the need to push ahead with reforms. The country’s foreign reserves rose slightly last month, while improvements in manufacturing data also help mitigate fears of capital flight.
Market Realist – There are several reasons why investors should not give up on China (GCH) yet.
China is in transition
There’s no doubt about the fact that the Chinese economy (FXI) is indeed slowing down. However, this slowdown may not be as alarming as it’s made out to be. The Chinese economy is undergoing a paradigm shift. While the country had been focusing on manufacturing activities, the focus has now shifted to the service sector, as the graph above shows.
The above graph from Goldman Sachs shows the shift currently underway in China (MCHI). Goldman Sachs has classified the commodities that China (FXI) consumes into two sections: “capex” commodities, which are used for industrialization, and “opex” commodities, which are used for personal consumption. Goldman Sachs analysts observe that the consumption growth in China for capex commodities like cement, coal, and steel fell between January 2015 and October 2015. On the other hand, opex commodity consumption of things like coffee and gasoline underwent a resurgence in consumption growth during this period. This trend is likely to persist this year as well. Thus, China is merely making a transition to a new normal. It’s vital to keep this fact in mind when evaluating concerns about a slowdown.
China still has room to grow
Demographics continue to support growth in China (ASHR), albeit not at double-digit levels. China’s real GDP per capita is still measured at $8,100, lower than the emerging market average (EEM) (FEO) of $10,600, showing that there is still some room to grow. Recent demographic reforms are likely to bode well for long-term economic growth. For example, relaxation of the “Hukou” system means that people can easily transfer from rural areas to seek employment opportunities in the cities (Source: BlackRock). The revocation of the one-child policy is likely to trigger a demographic shift, which can help boost household consumption and give way to a younger population in the long term.
Likelihood of an immediate debt crisis is low
Though China’s debt levels are undoubtedly humongous, the nature of the debt may not trigger a crisis anytime soon. As Terry Simpson of BlackRock has recently pointed out, in earlier debt crises (like the 1994 Mexico debt crisis, the 1997 Asian debt crisis, and the Brazil crisis in 2002), the majority of the debt was owned by foreign investors who pulled out their funds due to currency devaluations, thus triggering the crisis. On the other hand, Chinese debt is primarily owned by Chinese investors. According to UBS, ~90% of Chinese debt is owned by domestic investors (Source: BlackRock).