January money and credit numbers were strong, reinforcing the positive view here of near-term economic prospects.
The stock of total social financing (TSF, i.e. funds raised by households and non-financial enterprises, including government organisations) rose by 2.5% (not seasonally adjusted) in January alone, pushing annual growth up to 13.3%, the fastest since February last year. Within this, RMB bank lending increased by 2.7%, boosting annual growth to 14.9%, the fastest since February 2013.
The recent turnaround in credit trends is highlighted by six-month rates of change adjusted for inflation and seasonal factors. Six-month growth of real TSF has almost doubled from a low in August – see first chart.
TSF has been boosted by companies raising domestic finance to pay off external US dollar-denominated debt, but this cannot explain the extent of recent strength. According to the latest official data, external liabilities of non-bank enterprises fell by $35 billion during the third quarter of 2015. Repayments have probably increased more recently but even a $100 billion reduction over the last six months would be equivalent to only 0.5% of the stock of TSF.
TSF, moreover, has been subject to a simultaneous downward distortion from the local government debt swap programme, under which governments issue bonds to allow their related financing vehicles to repay bank and other debt. The bonds are not included in TSF but the debt of the financing vehicles is. The reduction in TSF growth due to the swap programme is probably larger than the boost from companies swapping external for domestic debt.
Annual growth of the official M1 narrow money measure increased from 15.2% in December to 18.6% in January, mostly reflecting the earlier timing of the New Year holiday this year – the annual rise in currency in circulation surged from 4.9% to 15.1%. Annual growth of the broader M2 aggregate firmed from 13.3% to 14.0%, above an expected 13% target for 2016.
The preferred money measure here for forecasting purposes is true M1, i.e. currency in circulation plus demand deposits of households and enterprises (official M1 excludes household deposits). A January figure is not yet available but the strength of the official measure suggests that six-month growth of real true M1 rose further, consistent with an expected recovery in economic momentum extending through the late summer, at least – second chart.
Money / credit buoyancy casts doubt on widespread expectations of further monetary policy easing, especially with the authorities reemphasising their commitment to a stable exchange rate. Reserve requirements, however, could be cut again as part of liquidity management operations to sterilise foreign exchange intervention – a neutralising measure rather than an easing.
Today’s Chinese numbers indicate that six-month growth of real narrow money remained stronger in the emerging E7 than the G7 in January – historically a favourable signal for emerging market relative equity performance.
The Bank of Japan (BoJ) has followed central banks in Denmark, the Eurozone, Sweden and Switzerland by imposing a negative interest rate on a portion of commercial bank reserves. In Switzerland and Sweden, the main policy interest rate, as well as the marginal rate on reserves, is below zero. Short-term interbank interest rates are negative in all five cases – see charts.
Danish rates were cut below zero to preserve the currency peg with the euro. Unwanted currency strength was also a key reason for the Swiss and Swedish moves to negative. The ECB and BoJ justify negative rates by reference to their inflation targets but both central banks have welcomed currency weakness in recent years.
An individual bank can avoid negative rates by using excess liquidity to increase lending or invest in securities. This is not, however, possible for the banking system as a whole, since the total amount of reserves is fixed by the central bank. A reduction in reserves by one bank will be matched by an increase for others. Negative rates, therefore, act as a tax on the banking system. The Danish, Swiss and Japanese systems reduce this tax by imposing negative rates only on the top tier of bank reserves.
Supporters of negative rates argue that a cut to below zero provides a net economic stimulus, even if the effects are smaller than a reduction when rates are positive. The move to negative, they claim, puts further downward pressure on banks’ lending and deposit rates, boosting borrowing and deterring “hoarding”. It also encourages “portfolio rebalancing” into higher-risk / foreign investments, implying a rise in asset prices and / or a fall in the exchange rate. Higher asset prices may yield a positive “wealth effect” on demand, while a lower currency stimulates net exports.
Opponents of negative rates argue that they squeeze banks’ profitability, making them less likely to expand their balance sheets. Banks in the above countries have been unwilling to impose negative rates on retail deposits, fearing that such action would trigger large-scale cash withdrawals. This has limited their ability to lower lending rates without damaging margins. Banks need to maintain profits to generate capital to back lending expansion. Any boost to asset prices from negative rates, moreover, is likely to prove temporary without an improvement in “fundamentals”, while exchange rate depreciation is a zero-sum game.
Radical thinkers such as the Bank of England’s Andrew Haldane have suggested increasing the scope and effectiveness of negative rates by placing restrictions on or penalising the use of cash. Such measures could allow banks to impose negative rates on retail as well as wholesale deposits without suffering large-scale withdrawals, thereby increasing their ability to lower lending rates while maintaining or increasing margins. Such proposals may be of theoretical interest but are unlikely to be politically feasible. They are dangerous, since they risk undermining public confidence in money’s role as a store of value.
Central banks’ experimentation with negative rates is likely to extend. ECB President Draghi has given a strong indication of a further cut in the deposit rate in March, while the recent BoJ move is widely viewed as a first step. The ECB may copy other central banks by introducing a tiered system to mitigate the negative impact on bank profits and increase the scope for an even lower marginal rate. The necessity and wisdom of such initiatives are open to question. The risk is that central bankers are opening Pandora’s Box and that any short-term stimulus benefits will be outweighed by longer-term damage to the banking system and confidence in monetary stability.
The PBoC’s fourth-quarter monetary policy report, released over the weekend, provides further evidence that monetary conditions have loosened, supporting an optimistic view of near-term economic prospects.
Bears claim that foreign exchange intervention has squeezed banking system liquidity, threatening a credit crunch. A previous post argued that the PBoC has more than offset the intervention drain by cutting banks’ reserve requirements. The latest report confirms this: banks’ excess reserves (i.e. the surplus over requirements) rose from 1.9% of their deposit base at end-September to 2.1% at end-December – see first chart.
With their liquidity position remaining healthy, banks have passed cuts in official benchmark interest rates through to borrowers. The average rate on loans to non-financial enterprises fell by a further 37 basis points (bp) last quarter, to its lowest level in data in data extending back to 2009; the average mortgage rate declined by 32 bp, to its lowest since the first quarter of 2010 – first chart.
In other news, foreign reserves fell by a further $99.5 billion in January, following a $107.9 billion December decline. The monthly reserves change exhibits a positive correlation with the spread between the offshore (CNH) and onshore (CNY) renminbi exchange rates versus the US dollar. The spread narrowed sharply last week, suggesting a slowdown in the reserves outflow – second chart.
Economic news flow is currently light because of the Chinese New Year. Last week’s Markit / Caixin purchasing managers’ surveys were encouraging, with both manufacturing and services polls stronger in January – third chart.
The OECD’s Chinese leading indicator*, meanwhile, accelerated further in December, according to data released today – fourth chart.
*See previous post for details of this indicator.
Posts here from the summer suggested that US economic growth would fall short of consensus expectations because 1) real (i.e. inflation-adjusted) narrow money had slowed sharply, 2) corporate finances had deteriorated and 3) the inventory cycle was turning down. GDP is currently estimated to have risen by only 0.7% annualised in the fourth quarter, reflecting falls in business fixed investment, stockbuilding and net exports.
The above-mentioned three reasons for pessimism remain in place. The six-month change in real narrow money has recovered from close to zero in October but is still low by recent and international standards – see first chart*.
The “financing gap” of non-financial corporations (i.e. the difference between their capital spending and retained earnings) fell back between the second and third quarters, although a wider net borrowing measure including share purchases remained high – second chart**. The gap may have narrowed further in the final quarter as fixed investment and stockbuilding declined. This “good news”, however, is probably outweighed by a rise in bond market financing costs: the yield on the Merrill Lynch high yield index, excluding energy sector bonds, increased by 150 basis points between the third quarter and January.
Stockbuilding, meanwhile, remained significant – equivalent to 0.4% of GDP – last quarter. With final demand slowing, the inventories / sales ratio in the GDP accounts rose to its highest level since 2011 – third chart. The stocks cycle, therefore, may continue to exert a sizeable drag in the first half of 2016.
The labour market is unlikely to be immune to these trends. Productivity fell in the fourth quarter, boosting unit labour costs and increasing pressure on firms to cut jobs. Several indicators are flashing warnings: the American Staffing Association staffing index – which measures demand for temporary and contract workers – has fallen year-on-year for eight months, the four-week moving average of initial jobless claims is up 9% from its recent low, while the employment component of the ISM manufacturing survey dropped to its weakest level since 2009 last month.
The risk is that a softer labour market causes consumers to retrench, tipping the economy over into a recession. For this reason, a previous post suggested paying close attention to consumer expectations in the Conference Board and University of Michigan surveys – expectations usually fall sharply at the onset of recessions. The Conference Board measure rose in January, with Michigan expectations unchanged – fourth chart. Consumers may have adjusted, at least partially, to a weaker outlook, with the personal saving ratio rising to a three-year high in December.
In addition to a sharp drop in consumer expectations, the previous post suggested that a recession would be signalled by a fall in the ISM manufacturing new orders index below 42.5 and / or a rise in the net percentage of banks tightening credit standards on commercial and industrial (C&I) loans in the Fed’s senior loan officer (SLO) survey above 20%***. The ISM orders index edged up to 51.5 in January, although regional Fed surveys were more negative – fifth chart. The net tightening percentage in the SLO survey, meanwhile, increased to 6% – final chart.
*The chart includes a US January estimate based on money data for the first three weeks and an assumed 0.2% monthly fall in consumer prices.
**A post in December stated that the wider measure had declined sharply in the third quarter but this reflected an error in the official data, which has since been corrected.
***Average of large / medium and small firm net percentages.
Claims have been made that recent large-scale capital outflows have tightened Chinese monetary conditions. Proponents of this view presumably pay no attention to monetary data, or even interest rates. As previously discussed, growth of money holdings of households and non-financial enterprises, on both narrow and broad definitions, has risen significantly since mid-2015 – see first chart*. In interest rate markets, the three-month repo rate is little changed from its mid-2015 level, while the yield on 10-year government bonds has fallen by 75 basis points – second chart.
A balance of payments deficit on the current and non-bank capital accounts, other things being equal, results in a contraction of broad money. In China’s case, however, this negative effect has been swamped by stronger growth of bank lending to the private and government sectors. Interest rate cuts, meanwhile, have boosted the demand to hold narrow money, with part of the increase probably reflecting stronger spending intentions.
More informed proponents of the claim that monetary conditions have tightened cite a fall in banks’ reserve holdings at the People's Bank of China (PBoC) – down by 9.0% in the year to end-December. This decline, however, has little implication for wider monetary and economic conditions – in the same way that rapid rises in reserves in Japan and the Eurozone due to QE have limited relevance for economic prospects there.
Declining (or expanding) reserves matter only if bank lending is liquidity-constrained. It isn’t. The PBoC has offset the fall in total reserves by reducing reserve requirements. In the US, the St Louis Fed calculates a reserves series adjusted for changes in requirements. No such official measure is available in China but, if it were, it would be rising**. If not, money market rates would be under upward pressure.
Rather than total reserves, excess reserves – the amount surplus to requirements – is the relevant metric for assessing the availability of liquidity to expand balance sheets. The PBoC releases quarterly data on the excess reserve ratio, with the latest data point for end-September, when the ratio stood at 1.9% – third chart. An end-December number is due shortly.
The key issue is not whether monetary conditions have tightened – they haven’t – but rather whether faster money growth will accelerate capital outflows, forcing the authorities to abandon their commitment to exchange rate stability against the new basket. Important considerations for forming a view on this issue are 1) the extent, if any, of currency overvaluation and 2) US dollar prospects – further strength would encourage additional speculative outflows. The judgement here is that Chinese exporters remain competitive, reflected in a rising share of global markets, while continued US economic weakness will cap the dollar.
*The measures in the chart exclude money holdings of government organisations.
**The reserve requirement ratios of large and small banks fell by 12.5% and 13.9% respectively in the year to December.