Aurelia Butler

ORLANDO, Florida (Reuters) – Of all the economic and market curve balls investors have had to bat away this year, few will be as unexpected as the U.S. economy growing faster than China’s.This was not how the 2023 consensus looked in January, when China was poised to break out of its COVID lockdown like a coiled spring, and the United States would buckle under the Fed’s most intense rate-hiking cycle in 40 years and slip into recession.But China is struggling to get off the ground, and the narrative around the U.S. economy is shifting, remarkably, away from a ‘soft landing’ towards a ‘no landing’ scenario.The contrast in the fortunes of the world’s two economic superpowers has been extraordinary, perhaps the starkest reminder that investors’ priors, rules of thumb and models have been completely ripped up by the pandemic.China’s economy grew by just 0.8% in the second quarter from the prior three months, down from 2.2% in a first quarter that was inflated by base effects as activity resumed after lockdown restrictions were lifted in December.The U.S. economy expanded 1.2% in the second quarter, following 1.6% growth in the first three months of the year. Hardly gangbusters, but more than comparable to a rival that should have been powering ahead.There’s little to suggest the economic dynamics are about to reverse any time soon, while tensions between the two powers over tech and cyber security, espionage and trade remain heated. According to the Atlanta Fed’s GDPNow real-time growth tracker, the U.S. economy is set to expand at a 5.8% annualized rate in the third quarter, which would be more than double the rate of annualized growth in the first and second quarters.Meanwhile, China’s growth outlook continues to darken. Economists at Barclays (LON:BARC) just cut their third and fourth quarter GDP growth forecasts to 2.8% from 4.9% on a quarterly basis, and lowered their 2023 call to 4.5% from 4.9%.That’s comfortably below the Chinese government’s full-year target of around 5%, a goal an increasing number of analysts think will be missed.China’s potential growth over the coming years is around double that of the United States, but there must be growing doubt about when China’s GDP will surpass that of the U.S.. Analysts at Goldman Sachs still reckon it will be in 2035 but Desmond Lachman, a senior fellow at the American Enterprise Institute, told Reuters recently that it probably won’t happen for at least 20 years. TALE OF TWO LANDINGSIlaria Mazzocco, senior fellow with the Trustee Chair in Chinese Business and Economics at the Center for Strategic and International Studies, says China is resilient and any talk of an economic collapse is far-fetched.But the era of double-digit and even high single-digit growth is over, and concerns over China’s weaknesses have proven to be well-founded.”There was a lot of talk in the last decade or so about China’s rise and America’s decline. What we’re seeing now is a reversal of that discourse” she said.”We may see similar growth rates between the U.S. and China, which is a concern for China because it is much poorer per capita,” she added.China’s GDP per capita last year was $12,720, according to the World Bank, six times smaller than the U.S. equivalent of almost $76,000. There’s a danger that the current narrative – U.S. optimism and Chinese pessimism – gets overblown. The historic highs and lows of U.S. and Chinese economic surprises, respectively, will likely revert to mean as analysts adjust their expectations.The ‘long and variable lags’ of 525 bps of Fed tightening have yet to fully hit the U.S. economy, and the highest bond yields since around the time of the Great Financial Crisis could choke Wall Street and Main Street later this year.Equally, authorities in Beijing could surprise markets and revive the economy with major monetary and fiscal stimulus. They’ve done it before.But there are good reasons why investors have pulled huge sums out of Chinese markets this year, why the gap between 10-year U.S. and Chinese bond yields is the widest since 2007, and why the yuan is also close to its weakest level since 2007.Deflation, record youth unemployment, an imploding property sector, historically low bank lending and plunging trade with the rest of the world are problems that are unlikely to be fixed quickly.”With this string of data disappointments, markets are likely to remain worried over prospects of a China hard landing,” Dirk Willer and his emerging market colleagues at Citi wrote this week.(The opinions expressed here are those of the author, a columnist for Reuters.) (By Jamie McGeever; Editing by Kirsten Donovan) More

The biggest question in global macroeconomics at the moment is whether China is on the cusp of a “balance sheet recession”. This sexy bit of economic jargon was first coined by Nomura’s Richard Koo to describe Japan’s lost decade(s), but is most commonly known as “Japanification”.It can be described simply as a protracted period of deflation, economic sluggishness, property market declines and financial stress as households/companies/governments unsuccessfully try to deleverage after a debt binge. Earlier this month, JPMorgan analysts Haibin Zhu, Grace Ng, Tingting Ge and Ji Yan published a fascinating deep-dive into the subject, which we have finally digested. The tl;dr is that JPMorgan’s economists see some spooky similarities between China today and Japan in the 1990s, but “enough differences to suggest the ‘balance sheet recession’ diagnosis, and policy recommendations that flow from it, is/are not correct”. That said, there are some aspects they highlight that actually look worse in China (a lot worse in some cases), so let’s dive in. The badAny fan of 1990s Dad Thrillers will remember Rising Sun, a film based on a book by Michael Crighton and starring Sean Connery and Wesley Snipes (it doesn’t get much more 90s than that). The subplot was America’s anxiety over Japan’s seemingly irresistible rise, which seems quaint in today’s eyes, but also very reminiscent about modern US angst over China.Sadly, JPMorgan doesn’t explore cinematic history in its report but notes that there are a few eerie other similarities between China’s current predicament and Japan’s in the early 90s. First is similarity in housing market development. As we have argued, China’s housing market correction since 2021 is not only cyclical (or policy-induced), it is also structural reflecting major changes in demand vs. supply in the housing market. This is similar to Japan’s housing market correction in the 1990s.Second is similarity in financial imbalance, i.e. the pace of increase and level of debt problem. According to the BIS, China’s total non-financial credit/GDP ratio approached 297% of GDP by end-2022, similar to Japan in the 1990s. Also similarly, debt is mainly domestic and domestic saving rate is high in both countries.The problem of population aging is also similar. The share of aged population (65 and above) was 12.7% in 1991 in Japan, similar to China in 2019 (12.6%).On the external front, Japan’s large trade surplus vs. the US led to trade conflict, as exemplified in the Plaza Accord in 1985 (5-6 years before the start of Japan’s lost decade) and US-China tariff war that started in 2018. From a broader perspective, the rise of Japan (30 years ago) and China (right now) to challenge the status of the US as the largest economy in the world is quite similar, leading to the fight-back from the US that initially focuses on reducing the bilateral trade imbalance.The goodBut there are some important differences as well (aside from the lack of a China-focused Snipes movie). Some of these differences are actually worse in China’s case, and some are better.Let’s look at what JPMorgan thinks are the “good” differences, before turning to the ugly. First of them (and JPMorgan reckons perhaps the most important difference) is a much lower urbanisation ratio in China. China’s urbanization ratio was 65% in 2022, and if excluding migrant workers who live in urban areas but do not have the same privileges as urban citizens, the hukou ratio was only 47%. In Japan, urbanization ratio exceeded 77% in 1988. Lower urbanization ratio points at larger potential for productivity increase associated with labor migration from agricultural to non-agricultural sectors. In the housing market, it suggests that China may have huge replacement demand for housing in the so-called new urbanization process, i.e. when non-hukou urban residents are granted hukou privileges and need to replace their rural area homes with urban-area apartments. The current gap of 18% of total population between urban population and hukou population implies potential housing demand from a maximum of 250 million people, or 100 million families.Second, China has a much larger domestic market, a larger pool of STEM graduates and comprehensive manufacturing sectors. While China may be facing a more challenging external environment than Japan in the 1990s, there is also hope that China can achieve technology upgrade and commercialization in some areas. For instance, China has become a leading player in new energy and new energy vehicles in recent years.Third, perhaps somewhat debatably, we think China’s housing price overvaluation is less severe than Japan in the 1990s. This is in part due to prolonged administrative control on new home prices and in part due to solid income growth. Our estimates show that housing affordability has continued to be a big problem in tier-1 cities: it took 21.1 years of household income to buy a 90-sqm apartment in 2010, and 16.6 years of household income in 2022. By contrast, housing affordability is much better in tier-2 and tier-3 cities that account for the majority of China’s housing market. Using the same house price/income measure, the ratio fell from 13.4 in 2010 to 8.3 in 2022 in tier-2 cities, and from 10.2 in 2010 to 6.1 in 2022 in tier-3 cities.Fourth, China’s capital account is not fully liberalized. This will reduce the risk of fire sale of domestic assets (mainly housing) to invest overseas. In fact, many households still choose to hold multiple homes amid housing market corrections, because house price decline has been modest due to government control and, in addition, there are limited options for alternative investment.Lastly, the Chinese government has stronger control of both asset and liability sides of the debt problem. This could be a double-edge sword: it implies that the probability of a sudden-stop debt crisis is smaller in China, but the zombie parts of the economy will continue to stay and likely further expand, intensifying the moral hazard problem and weakening incentives for structural reforms. This may crowd out more productive activities in the economy and lead to faster-than-expected slowdown in economic growth.So, less urbanisation; a less extreme property bubble; capital controls and many government policy levers that can still be pushed and pulled. Which are all admittedly pretty major differences. Unfortunately for China, it differs from 1990s Japan in some . . . suboptimal ways. The uglyJPMorgan’s main concern is that China is actually ageing more rapidly than Japan was, which has led to predictions that it will ‘grow old before it grows rich’ — a kind of demographics-caused middle-income trap. In Japan’s case, the share of population aged 65 and above exceeded 10% in 1983, and exceeded 14% in 1994. The birth rate fell from 12.7 (per 1000 people) to 10.0 during that period. In China’s case, it took only 7 years (from 2014 to 2021) for the 65 plus population to increase from 10% to 14% of total population, and the birth rate has fallen faster from 13.8 (per 1000 people) to 7.5 during that period (and further down to 6.77 in 2022, similar to Japan in 2020 at 6.80). In addition, China’s total population started to decline in 2022, while Japan’s total population started to decline in 2008, nearly two decades after the start of the lost decade.Second, China’s GDP per capita was around US$12,800 in 2022, much lower than Japan in 1991 at US$29,470. While lower GDP per capita may imply higher growth potential, it suggests that China is becoming old and high-indebted before it becomes rich.The accompanying chart is pretty stark:

Moreover, JPMorgan’s economists also point out that the global economic backdrop is worse for China than it was for Japan in the 1990s, and thinks the Chinese government has less scope for stimulative fiscal measures than is commonly assumed:. . . The external environment is more challenging for China nowadays. The strategic competition between China and the US is, in our view, more complex and multifaceted than the trade dispute between Japan and the US in the 1990s. In recent years, technology decoupling from the US has replaced the tariff war to become the major challenge for China. Beyond the bilateral relationship with the US, the globalization process has slowed down notably after 2008 (when the share of global trade as % of global GDP peaked), in sharp contrast to the golden days of globalization in the 1990s. The Russia-Ukraine war in 2022 further accelerated global supply chain relocation, which weighs on China’s potential growth.Moreover, the room of macro policy stimulus is more limited in China nowadays than Japan in early 1990s. On the fiscal side, government debt was 61.9% of GDP in Japan in 1991, the start of the housing bust. Government debt rose to 131% of GDP by 2000 in Japan. In China’s case, although central government debt was only 20% of GDP, if adding local government debt and LGFV debt, total public debt reached 95% of GDP by end-2022.Here’s the chart showing that:

As a result, JPMorgan warns that “the room for fiscal stimulus for China in the next 10 years is much smaller than Japan in the 1990s”. Nor do its economists think that China has any more scope to combat the economic miasma with monetary policy.Similarly, on the monetary policy front, the BOJ’s policy rate was 8.1% in January 1991. The BOJ moved quickly after the housing bubble burst: by end-1993, the policy rate was cut to 2.4%; and in 1999, the BOJ became the first central bank to adopt zero interest rate policy. By comparison, China’s policy rate (7-day reverse repo rate) is already as low as 1.9%. The room for policy rate cuts for the PBOC, if deemed necessary, is much smaller than the BOJ in early 1990s.What’s the diagnosis, doc?So why then does JPMorgan think that China isn’t about to suffer a Japan-style long-term balance sheet recession? It boils to the differences between “ordinary” economic downturns and Koo’s diagnosis of Japan’s pretty unique travails. When asset prices fall, firms face binding borrowing constraints with balance sheet deteriorating, forced asset sales can further push asset prices lower and form a self-reinforcing downward spiral between asset prices and economic activities. In other words, asset price decline is critical in understanding the phenomenon of balance sheet recession.Following this argument, balance sheet recession is not a reality yet in China. The Chinese government has adopted the strategy of protecting house prices but letting volumes correct dramatically. This is in sharp contrast to the Japan’s episode, when prices and volume fell simultaneously. As a consequence, the macro cost (sharp decline in volume activity and slower real estate investment) is larger in China, but the benefit is that financial risk associated with asset price decline has stayed under control.Also Japan’s balance sheet recession manifested itself in a huge deleveraging by households and companies, but a massive increase in the government’s debt burden. Corporate debt fell from the peak of 144.9 per cent of Japan’s GDP in 1993 to 99.4 per cent in 2004, and household fell from 71 per cent in 1999 to 60 per cent in 2007, even as government debt ballooned, pushing the overall burden for the economy as a whole higher. In contrast, China’s debts have been building up across the board with hardly any interruptions since 2008, and this is likely to continue, according to JPMorgan.First, China’s economic structure has been characterized by high investment, and high savings. The much larger share of investment (vs. consumption) and manufacturing (vs. services) than other economies implies that the Chinese economy is more credit-driven, i.e. naturally debt-driven. Second, China’s financial market has been dominated by indirect financing (via bank loans), and bond financing has risen faster than equity financing in recent years in capital market developments. This also leads to continuous debt increase. In order to slow down the pace of debt increase, the government will need to push forward capital market development (especially equity market, PE/VC, etc.) and the transformation of economic structure from high credit-intensify to low credit-intensity sectors. This means a policy shift from investment to consumption, and equal support for upgrading of both services and manufacturing sectors. There were encouraging changes in China’s economic structure in the past decade, but the trend has somewhat been reversed in recent years.Here are some charts showing that shift (zoomable chart 1 and zoomable chart 2):But the fact that Chinese debts have continued to rise and are likely to do so for the next few years — and that the property market hasn’t imploded yet — is not really an argument against China’s Japanification. Indeed, it might only indicate that a full-scale version just hasn’t started yet.Moreover, no economic crisis is ever going to be identical. Of course China will not follow Japan’s economic trajectory perfectly, or even vaguely. They’re very different countries, and these are very different times. But there are enough broad similarities to think that the overall disease — a protracted period of declining demographics, economic sluggishness, deleveraging and deflationary pressures that defies fitful government efforts to dispel the miasma — might end up being pretty similar. More

BENGALURU (Reuters) – The U.S. Federal Reserve is likely done raising interest rates, according to a strong majority of economists polled by Reuters, and a slight majority now expect the central bank to wait at least through end-March before cutting them. With the world’s largest economy defying nearly every negative forecast, and unemployment around a more than five-decade low, the median probability of a recession within a year fell to 40%, its first time below 50% since September 2022.A 90% majority, 99 of 110 economists, polled Aug 14-18 say the Fed will keep the federal funds rate in the 5.25-5.50% range at its September meeting, in line with market pricing. A roughly 80% majority expect no further rate rises this year.That contrasts with minutes from policymakers’ recent deliberations, showing a split on whether one more rise might be required. After raising rates by 25 basis points last month, Fed Chair Jerome Powell kept options open for whether there would be a hike or a pause at the September meeting. “Chair Powell says that decision will come down to upcoming data on growth and inflation, which we suspect will show enough signs of moderation to dissuade further rate hikes,” noted Sal Guatieri, senior economist at BMO Capital Markets. “Still, a move to lower the current target range of 5.25%-5.50% is unlikely to begin until about June 2024 given the expected sluggish path of inflation back to the target.”The Fed’s preferred gauge of inflation has fallen sharply from a peak of 7.0% following 11 interest rate hikes from near-zero in early 2022. But it is not expected to fall to the 2% target until at least 2025, according to the poll. Greater confidence the economy may skirt a major downturn has led to growing expectations rates will stay higher for longer, leading to convulsions in bond markets in recent days. The benchmark 10-year Treasury note yield is now only a few basis points off its cycle high in October. Indeed, 23 poll respondents said rates will rise once more this year, with two saying twice more, to 5.75-6.00%. While a majority among 95 economists who have forecasts through mid-2024 say rates will fall at least once by then, there is no majority for the timing of the first cut. Just over half, 48 of 95, said the Fed will hold off cutting rates through end-March, with another 45, or 47%, saying its first cut will come in Q1. The other two still expect a cut in the fourth quarter of this year. As recently as June, over a three-quarters majority of economists polled said the Fed would start by end-March. Another 33 respondents, roughly 35%, forecast the Fed will go for its first rate cut in Q2, leaving 79 of 95, or 83% expecting at least one rate cut by mid-2024.SHELTER COSTS TO COME DOWNMuch will depend on how quickly inflation will fall in the last stretch from 3.0% currently on the personal consumption expenditures (PCE) index to the Fed’s 2% target. Shelter costs – which account for around a third of the consumer price index (CPI) basket and are one of the main current drivers of inflation – will fall over the rest of the year, said nearly three-quarters of economists, 23 of 31.That would help price pressures decline over the coming months, making the fed funds rate adjusted for inflation – the real interest rate – more restrictive if held unchanged.Adjusting that real rate of interest would most likely be the reason for a rate reduction from the Federal Open Market Committee next year rather than a first move toward stimulus, said 21 of 32 economists in a reply to another question on what will prompt the first rate cut.”We have long seen a high threshold for cutting because Fed officials will want to minimize the risk they could regret cutting if inflation stays too high,” said David Mericle, chief U.S. economist at Goldman Sachs.”The cuts in our forecast are driven by this desire to normalize the funds rate from a restrictive level once inflation is closer to target, not by a recession.”(For other stories from the Reuters global economic poll:) More

(Reuters) -Estee Lauder projected annual sales and profit below estimates on Friday, signaling a slower-than-expected recovery in its travel retail business, mainly in Asia, and easing demand in the United States. Shares of the company were down 6% in premarket trade. Major global companies have taken a cautious stance on their China recovery, as the world’s second-largest economy struggles to revive demand and battles rising youth unemployment rates and a high cost of living. Analysts have said the drop in consumer demand in China and a slow recovery in Asia travel retail – sales made at airports or travel destinations like Korea and China’s Hainan – could impact luxury companies like Estee, which makes about 30% of its annual revenue from the Asia Pacific region.”Asia travel retail pressured results, particularly in Skin Care, and we continued to experience softness in North America,” CEO Fabrizio Freda said.Estee’s Americas region reported flat net sales, while Asia Pacific reported a 29% increase in sales in the quarter.European luxury rival LVMH last month also flagged cooling demand in the U.S.French cosmetics maker L’Oreal, which beat estimates on a China rebound, however said the Chinese market was not picking up at the speed everyone had hoped for.Estee’s expectations of a dour first quarter also led analysts to raise questions about the continuing uncertainty in Hainan and Mainland China. “De-stocking and inventory levels in Asian Travel Retail… likely to remain the biggest headwind to growth over the next few quarters,” said Bernstein analyst Callum Elliott. Estee expects full-year sales to rise between 5% and 7%, compared with analysts’ estimate of an 8.8% increase, according to Refinitiv data. It sees annual adjusted profit to be between $3.50 and $3.75 per share, compared with an expectation of $4.83. More

LONDON (Reuters) -Argentina presidential candidate Javier Milei is set to meet International Monetary Fund (IMF) representatives on Friday, just days after a shock primary election roiled the cash-strapped nation’s markets.Speaking in a radio interview on Thursday, Congressman Milei said he will participate in the discussions. He is expected to be joined by his economic advisers Carlos Rodriguez, Roque Fernandez and Dario Epstein, according to a person familiar with the discussions.The director of the Fund’s Western Hemisphere Department Rodrigo Valdes and deputy director Luis Cubeddu are set to take part in the virtual meeting, along with the mission chief for Argentina Ashvin Ahuja and the IMF Senior resident representative in the country Ben Kelmanson.A spokesperson for the IMF did not immediately respond to a request for comment during early U.S. hours.Right-wing Milei received 30% of the vote in Sunday’s election, the most of all the candidates ahead of an Oct. 22 presidential vote. The 52-year-old economist has a bold vision to dollarize the economy, get rid of the central bank, cut government spending and eliminate and cut taxes, among other measures.The surprise result sparked turmoil in the country’s bond and currency markets, triggering the central bank to hike interest rates by 21 percentage points and the government to devalue the currency by 18%.Argentina’s economy is the largest debtor to the Washington-based lender, with a $44 billion loan. The IMF’s executive board will meet on Aug. 23 to discuss a $7.5 billion disbursement to Argentina after it reached a staff level agreement on two combined reviews of the programme in July. With negative net foreign currency reserves and a maze of capital controls to protect the plunging peso, the country needs the IMF money to repay the Fund’s maturities. Milei will face the conservative opposition candidate Patricia Bullrich and the Peronist and Economy Minister Sergio Massa in the vote. More