Emiel: Does China’s reluctance to stimulate its economy mean we should expect lower growth and higher volatility?
Erik: In the past, the authorities put a floor under growth shocks via large stimulus packages. So if China lowers that floor, average growth should indeed be lower. But one could go even further. Increasingly, positive growth shocks are likely to be capped by additional deleveraging and rebalancing towards consumption. This would weigh further on average growth.
However, more importantly China will no longer be the buffer for the world in case we get a global slowdown. In 2008 Chinese stimulus was one of the crucial stabilisers; next time they might not be so forthcoming with stimulus.
Emiel: Interesting. If China is now only prepared to intervene later and on a smaller scale, doesn’t that increase the risk of a hard landing in the country?
Erik: It depends on the time horizon. The fact that the leadership is tackling leverage, the economy’s key vulnerability, reduces the chances of a hard landing over the medium term. Over the shorter term, however, this approach allows for more stress in the system and so does increase the risk of a hard landing. The authorities nevertheless still have many policy levers and this risk remains moderate.
Given that economic context, Emiel, what do you see as the key investment implications of this regime change?
Emiel: There are many. I’d start with commodities and, in particular, metals. China has typically stimulated via commodity-intensive infrastructure investment and construction. Less stimulus in China would weigh on these prices. Many emerging markets are commodity producers, so they would suffer as well. I would be most worried about metals producers such as Chile and South Africa.
Probably one of the more obvious impacts is on emerging-market equities. Weaker global growth, weaker commodity prices, and a weaker renminbi provide a headwind, especially for emerging Asia and exporters of industrial metals.
Erik: What about the fallout for developed markets?
Emiel: Given China’s size – it accounts for 30% of global growth – there are few corners of the world where the impact of this regime change won’t be felt. Growth in the US and, to an even greater extent, Europe should become more volatile. With that, investors are likely to demand higher risk premiums. Weaker Chinese demand and softer commodity prices would also ensure that global inflation remains lower for longer, benefitting long-term bond positions. I would also expect an impact on the renminbi.
Erik: Yes, I agree. With the space for policy stimulus in other areas shrinking, the renminbi should become more of a shock absorber. We could, for example, see another leg down if the upcoming trade talks fail and more tariffs are imposed. Over the longer term, the renminbi should still appreciate given larger productivity gains in China than in the US and Europe, but we’ll see larger swings around this trend. How would you trade that?
Emiel: A view on a weaker renminbi can be expressed through many currencies. In fact, a recent IMF study found that a larger part of the global economy moves in lock step with the renminbi than with the euro. My preferred option would be currencies that offer positive carry when shorted, such as the Taiwanese dollar.