Remember the G-20 “Shanghai Accord” from February 2016, a meeting where the world’s political and financial elites were rumored to sit down and unveil a plan how to boost the global economy? Well, according to a new research note out from Deutsche Bank, it was this event – together with the unprecedented credit expansion out of China that immediately followed – that catalyzed the ongoing global economic rebound, a recovery which has had nothing to do with confidence in Donald Trump policies.
And, according to Deutsche analysts, it is time to get worried again because if China was indeed the catalyst for the global growth impulse into the end of 2016, and early 2017, then the global growth is about to roll over, as the Chinese-growth impulse is coming to an end as the following analysis suggests.
Here is why DB’s Oliver Harvey is increasingly betting that the period of smooth economic calm is coming to an end, and why he believes it is time to start getting long FX vol.
One puzzle this year has been divergence between global political uncertainty and vol.
Structural shifts in US policy, from trade to Asia to the country’s strategic relationship with the EU, offer lots of potential for major FX moves (not to mention the European political calendar, Chinese outflows and Brexit negotiations). Yet the three month vol premium remains negative for almost every major FX pair. Longer dated vol, while in many cases higher, isn’t historically that elevated either.
The reason is booming global growth, with data surprises and many PMIs at multi-year highs. Our colleague’s previous research found the most robust driver of FX vol to be growth measures including US industrial production and world commodity prices. The question for markets then is if, or when, growth rolls over.
On that front attention has focused on President Trump, but developments on the other side of the world may prove more important. At the beginning of 2016, China embarked on its latest fiscal stimulus funded from local government land sales and a booming property market. The Chinese business cycle troughed shortly thereafter and has accelerated rapidly since.
Germany’s China-sensitive economy bottomed almost in sync, and exports to the east have now reached multi-year highs (chart 3). The US and the rest of the G7 followed with around a six-month lag. The most important reason for the current feel-good factor may be Chinese policy decisions from 12 months ago, not hopes for the US policy mix.
That makes last week’s softer-than-expected official and Caixin PMIs a concern. Land sales, which have led ‘live’ indicators of Chinese growth such as railway freight volumes by around 6 months, have already tailed off significantly.
Chinese policy has also become increasingly boxed in by the need to prevent persistent FX outflows, which explains a large tightening in monetary policy over recent weeks. Today’s reserve numbers show that despite such attention from the authorities, outflows remain robust in January.
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DB’s punchline:“If China starts to slow again, the current risk-friendly environment has a short sell-by-date, particularly given rising oil prices and our view that any Trump stimulus will take at least a few quarters to work its way into US growth.”
DB may be right, but judging by the new all time highs across all indices as of this moment on the back of comments from, well… Trump, while the global economy may be about to roll over, equities are clearly driven far more by Trump than any worries about what Beijing may or may not be doing.