China economic shock waves unsettling AUD
A shock drop in Chinese trade, worries over China's economy and a rampant stock market rally are sending shivers through commodity currencies and in particular the AUD. Chinese efforts to rebalance its economy are likely to stoke further losses for AUD for the foreseeable future.
Unless the Chinese government launches a major stimulus programme AUD/USD could test support around 0.7000 or even lower. There are signs that the Chinese authorities are becoming progressively more aggressive with economic and financial liberalisation plans in play, interest rate cuts from the People's Bank of China and so on.
And it is looking increasingly worrying. In March Chinese imports plunged by 12.3% and exports by 14.6% (both numbers confounding predictions) and the monthly trade surplus shrank by a hefty 62.6%.
Certainly, China has been on a slowing trend for a couple of years – but Q1 numbers due Wednesday may reveal an even bigger slowdown than anticipated possibly very close to 7%. Some China observers, when extrapolating data from electricity output, rail freight movements etc … put real GDP numbers at 3% in contrast to recent official numbers at over 7%.
Australia has particular reason to fear a Chinese slowdown given China is its main trade partner. Prices of Australia's key export to China – iron ore – have been falling steadily since 2014 recently hitting around $50/tonne from $135/tonne in December 2013. That's more dramatic than the fall in oil prices.
AUD/USD – exchange rate dictated by events in Beijing
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Following the West's financial crisis from 2007/8, China pursued an aggressive fiscal and monetary stimulus programme to shield its economy. However, it has left a raft of massive infrastructure white elephants, a large property bubble, which is now unwinding and large amounts of poor quality debt in danger of going bad.
China seems to be adopting the tactics used by the US, UK, Japan and now the Eurozone and Sweden, which is aggressive monetary stimulus creating a rise in the value of financial assets in the hope of creating a 'wealth effect' to stimulate spending in the real economy. Though the PBOC has not resorted to outright QE unlike the aforementioned countries.
It's also hoped that it will help lenders recapitalise their balance sheets – particularly weaker 2nd and 3rd tier lenders – by raising new equity and by making assets that support their loans more valuable.
The problem is that China's stock markets, which have rallied dramatically recently, are starting to resemble casinos with a growing number of speculators hoping to get rich quick. This kind of thing tends to end badly. It looks awfully like China's policy makers are trying to smooth the effects of their real estate and infrastructure bubble popping with another bubble.
At the same time the authorities are trying to guide the economy towards domestic consumption and away from infrastructure investment and exports. It's very unclear how this will play out and there will be a lot of volatility and uncertainty during the transition, which will weigh on AUD/USD.
About the only thing that seems certain is that China's long-term economic growth rate looks as if it will glide permanently towards lower numbers, not least because the country faces a demographic time bomb.
Thanks to the one child policy enacted in 1980, China's population will steadily have less workers to support more retired people. The only way to offset that is through higher productivity. At least China has the potential to substantially increase its productivity in the coming years.
By Justin Pugsley, Markets Analyst, MahiFX