Although the U.S. non-farm payrolls data in May exceeded expectations, the timing of US rate cuts remain unclear. The Fed's meeting in May didn’t provide policymakers with sufficient confidence about US economic conditions, not to mention a rate cut. At the meanwhile, Fed Chairman Jerome Powell's tone has also turned hawkish.
In Asia Pacific, Asian stock markets and currency markets are under pressure. With Renminbi once again fell back against the US dollar, China's stock market began to consolidate after the rebound. While changes in global macro policies will certainly have a spillover effect on China, the sustainability of the economic recovery remains most critical for international investors after China has launched a series of stimulus policies.
In this story, Arend Kapteyn, UBS Global Chief Economist and Tao Wang, Head of UBS Asia Economics, Chief China Economist shared their insights and analysis about the US economic data and China’s policy development for recovery against the background of global macro-environment.
Q1: This series of contradictory signals continue to dampen market expectations for the magnitude of interest rate cuts, and even more people are skeptical about whether rate cuts can still happen this year. How to interpret mixed U.S. economic data?
Arend: A feature of the US data for some time now has been that the cyclical and interest sensitive parts of the economy are weak (e.g. production, trade, parts of investment) while consumption has remained strong. Thus, we have been in an unusual situation where the US economy is motoring along at roughly a 3% growth pace, but the recession probability models have remained very elevated (because they run off the cyclical/interest-sensitive data which normally leads the cycle).
However, what is now starting to happen is that the part of the economy that was strong (consumption) is slowing, while the part that was weak (production/investment) is starting to gradually improve. Indeed, UBS’s ‘hard data’ recession probability model for the US fell below 50% this month for the first time since mid-2022, despite some economic data published previously starting to soften. “In any event, because consumption is the larger part of the economy, we think that on balance growth will be lower in the coming quarters, but it is a slowdown from very high levels.”
In my view, one way to think about the dynamics that have unfolded is that expansionary fiscal policy has provided enormous buffers to consumers that have taken a while to deplete, while the production side of the economy has been under pressure from the significant increase in interest rates to contain inflation. As the Fed moves closer to reducing its Fed funds rate, the interest sensitive parts of the economy will start to recover.
We can already see how sensitive housing indicators are to swings in market determined mortgage rates for instance. It looks like that interest rate relief is coming just in time because we are seeing cracks appear in the US consumer. For instance, the New York Fed has a survey suggesting that consumer distress on credit cards and auto loans is approaching levels not seen since the Global Financial Crisis in 2008/2009. That suggests a striking dichotomy within the US consumer base. We can see that in the Flow of Funds data.
The lower income cohorts of the population (0th to the 40th percentile) have depleted their excess savings (stimulus checks, generous benefits) and liquidity over the last few years and, relative to spending, have funds that are about a standard deviation below historical average. The middle-income groups (40th to 80th percentile) have essentially depleted their surplus funds accumulated during the pandemic and are back at a long run average of liquidity vs spending. However, it’s the top 20% which appears to be carrying the expansion. Their liquidity buffers are still a full standard deviation higher than the long run average, and this is also where close to 80% of all the financial assets are concentrated. UBS estimates that the top 20% of the income distribution may be generating 40% or so of the consumption growth, which is an unusually high amount. But the demand base behind consumption growth is clearly narrowing.
Q2: How do you see the US monetary policy trajectory? Do you think the Fed tends to err on the side of precaution to keep interest rates at restrictive levels for longer to contain the suborn inflation, drawing the lesion from the 1970s?
Arend: Our baseline is that the Fed will cut rates in September and December this year. However, we are not in the camp that believes that the timing of the US election somehow restricts the ability of the Fed to cut, if the data were to warrant it. Indeed, in the last 17 presidential elections the Fed has hiked or cut 10 times within 3 months of an election.
The issue for the Fed is that, after several months of stalling inflation process, they need to accumulate a sequence of several months of improvement. That automatically means that it’s difficult to see cuts before September as there is just not enough time to accumulate a sequence of improving inflation data.
Because the Fed is a ‘dual mandate’ central bank, targeting both inflation and full employment, it is possible that a slowing on only one side of the mandate would be sufficient to trigger a September cut. For instance, if we see monthly core inflation prints slow to an annualized rate of 2% for 3 months or more, but the labor market remains strong and unemployment moves sideways, then that’s probably enough for them to cut. Conversely, if monthly core inflation does not materially slow from current level, the other way cuts could be triggered is if we see a very sharp slowdown in the labor market. For instance, a negative payroll prints or a few months of something closer to zero payroll growth, would likely give the Fed confidence that a slowdown is coming that will also pull inflation down (but strong May nonfarm payrolls data largely ruled out this scenario).
We certainly agree that, absent a sharp slowing in the labor market, the Fed can afford to be patient and wait with cuts until the inflation data improves. They will be worried about de-anchoring inflation expectations if they cut too early.
Q3: China’s macro conditions started to show signs of stabilization from February this year. How do you read into the improving data points?
Tao: China’s economic growth rebounded and was better than expected in the first quarter this year, though April data showed a mixed picture. Indeed, an important help comes from resilient global demand for China’s exports, partly as growth in the US and globally has been better than earlier expected, and partly as the global destocking ended. Also importantly, the anticipated upswing of the global electronics product cycle started from late 2023, resulting in a rebound in electronics exports. Domestically, the strong release of pent-up travel and going-out demand around the time of the Chinese New Year holiday helped to boost services sector in Q1, reflecting the post-Covid recovery.
However, in contrast with the recovery in exports and services, property sales and construction declined further in the first few months of 2024, continuing to be a drag to the overall economy. In addition, consumer and producer prices remained weak or in decline, with nominal GDP growth only at 4.2% in Q1.
Q4: Do you think the momentum will be sustained? How do you see the performances of export, consumption and investment going forward?
Tao: Although March-April exports have showed slowing momentum compared to January-February, we believe China’s overall exports will be stronger than in 2023 and expects exports to grow by 3.5% in USD terms this year compared to -4.6% in 2023, and real exports to grow even stronger. Net exports are expected to contribute 0.5 ppts to GDP growth in 2024, compared to a net drag in 2023.
On investment, we expect real estate investment to decline further (slightly less than in 2023). Meanwhile, the central government's explicit funding support through special treasury bonds can help support infrastructure investment, keeping it from weakening from 2023 pace despite controls on LGFV debt. Manufacturing investment is likely to grow at a similar pace as in 2023 as investment in sectors with strong growth offset the decline of investment in industries with excess capacity or low profit margins.
After the release of Q1 data, we have already upgraded China’s 2024 GDP growth forecast from 4.6% to 4.9%. UBS thinks the biggest downside risk to growth will likely be from the ongoing property downturn, which can have persistent negative impact not only on construction, but also on local government spending and household consumption. Therefore, I also believe that the sustainability of the growth momentum depends critically on whether property activity can stabilize in the coming months.
Q5: Domestic demand remains lackluster and deflationary pressure persists though the timing and scale of policy stimulus remain in question. What are your expectations for the fiscal and monetary policies?
Tao: In the future, policy support may be further ramped up. I don’t expect any MLF rate cut this year though there may be room to guide banks’ LPR rate by another 10-20bps alongside with more reduction of bank deposit rates. Consistent with my forecast, the mortgage interest rates and down payment required have been further lowered. The central government, potentially through the PBC and the banking system, has provided low-cost funding for local governments and state-owned enterprises to absorb property inventories. Moreover, the government has expanded the “white lists” of credit support to developers to help ensure delivery of stalled property projects.
Q6: Despite the early signs of stabilization, the property sector showed another sharp decline in April. How do you see the sector in 2024 and its drag on consumption and investment?
Tao: Indeed, property activities declined further in April, with the NBS reporting a nationwide sales decline of 23% y/y and new property starts down 14% y/y from a low base. We have long expected more policy support from the government, including more credit support to help developers and measures to boost demand. On May 17, the same day property data were reported, the government unveiled a set of property easing measures to try to stabilize the market and ensure home delivery of presold homes.
One of the key measures is the expansion of the “whitelist” through which developers get credit from banks to help continued home construction, that is on top of the RMB 900 bn of credit that has been approved between January and mid-May. In addition, the PBC announced a RMB 300bn lending facility for social housing, which can result in a total of RMB 500bn of bank lending to local entities for the use of purchase finished but unsold inventories. Other measures include lowering of mortgage down payment requirement, mortgage interest rates, and buyback of land by local governments to help developer cash flow.
With these and other existing policy measures, our baseline expectation is for housing sales and new starts to stop falling on a m/m seasonally adjusted basis in the next 2-3 months and rebound modestly afterwards. For 2024, we expect property sales volume to decline by 5-10%, new starts to decline by 15-20%, and real estate investment to decline by 5-10%. All slightly less bad than in 2023. UBS also expects average home price to decline not much more than 10% this year. Under this baseline scenario, the drag of property on the overall economy may be slightly smaller than in 2023.
However, UBS Evidence Lab survey showed that weak property market sentiment – with more people expecting home price decline than before and home purchase intention low. The weak property sales and construction negatively affects labor market and income growth, and lower property prices means a negative wealth effect for the household sector, which has 60% of their assets in property. Both will limit the strength of consumption growth this year. In addition, weak property market also hurts local government finances, which puts downward pressure on local government spending and infrastructure investment, even with more support from the central government in the form of special treasury bonds. Hence, UBS thinks infrastructure investment will unlikely grow faster than in 2023, while real estate investment may decline slightly less than in 2023.
