China expedites economic transition
China was criticized last year when it unexpectedly set the renminbi exchange rate 3% lower overnight against the dollar. The move triggered fears about the Chinese economy and extraordinary volatility in global financial markets. But Beijing didn’t devalue for no reason. The devaluation was conducted to “confront the deflationary pressures arising from the 30% increase in China’s real effective exchange rate over the past four years,” according to Carlyle Group economist Jason Thomas. It also gave the People’s Bank of China (PBOC) room to maneuver with monetary policy.
The move has had much of its intended effect. Factory price deflation has declined markedly and interest rates have been slashed, easing the massive debt burden on Chinese corporations. “Real debt service burdens in the Chinese industrial sector have already declined by more than four percentage points,” Thomas wrote, “the simplest solution turned out to be the best” in combatting a potential deflationary spiral. The effectiveness of the move would lead you to believe another significant devaluation might not be the worst idea, although it would export deflationary pressures around the world.
While China has taken small steps to confront its debt problem, the issue is nowhere near solved. The International Monetary Fund (IMF) this week warnedChinese credit growth is unsustainable, urging “decisive action” to tackle vulnerabilities in lieu of hitting unrealistic growth targets.
Government policy has alternated between prioritizing reform and growth, but right now China appears serious about getting on a healthier diet. The result of market-based reforms has been “disappointing data on all fronts from product and investments to credit and money,” according to Societe Generale analyst Wei Yao. Fixed income investment growth is negative in the private sector and down from 24% to 14% in state-owned enterprises (SOEs). Fiscal spending was basically flat in July after growing 15% in the first half of the year. New bank loans came in at a third of what they were in June.
All the while, Chinese companies, many with state-backing, are traversing the globe in search of boring, reliable foreign investments. Insurance companies are popular, as are hotels and utilities. But not every Chinese approach has been well-received. When a Chinese firm bid $7.7 billion for Australia’s biggest energy grid, the Aussies drew a line in the sand. The government’s decision to block the move over national security concerns angered the Chinese, who called the decision protectionist and likely to adversely effect future Chinese investment down under.
It’s not the first time the Australian government has had to make a touch decision regarding a controversial Chinese takeover bid. It previously rejected a Chinese offer to buy the country’s largest agricultural land owner, cattle company Kidman & Co.
Last year it approved a A$506 million long-term lease for Landbridge Group, a company owned by Chinese billionaire Ye Cheng, to operate Darwin’s port in the north of Australia, much to the chagrin of the United States. President Obama reportedly expressed anger at the Australian Prime Minister’s lack of communication about the decision and the U.S. ambassador emphasized national security issues must be taken into account when dealing with foreign direct investment in sensitive areas like infrastructure. Because of how much trade takes place between the two countries, China’s forwardness could continue to put Australia in an uncomfortable position.
Germany was recently more receptive to China’s advances, green-lighting the sale of robotics firm Kuka to Chinese appliance maker Midea. The deal has been controversial because it involves the transfer of valuable technology, but the government is confident it won’t harm national interests. The deals wave underscores the Chinese corporate sector’s desire to find higher-yielding investments beyond its own great walls.
On the bright side, it appears China’s transition to a consumption-driven economy is on track. Research firm eMarketer projects China’s retail sales to exceed that of the U.S. by the end of this year.
China also approved the launch of a scheme to allow stock trading between Hong Kong and Shenzhen, the world’s second-busiest exchange. The move is likely designed to allay concerns about market access, which were cited by MSCI as one of the reasons for not including China A-Shares in its benchmark emerging markets index.
U.K. ECONOMY SENDING MIXED SIGNALS AFTER BREXIT
On the Brexit front, this week brought some good news and some bad.
First, the good news: the British economy is actually holding up well post-referendum. Downbeat housing data has stoked fears about recession, but this week three data points — inflation, jobless claims and retail sales — all came in better than expected. The news will be particularly welcomed by the Bank of England (BOE), which recently cut its key interest rate to 0.25% and introduced a term-funding scheme but, having expressed a distaste for negative rates, is seen as near the limits of its monetary policy.
Now for the bad news: banks are reportedly speeding up plans to take jobs out of London after Brexit rather than waiting around to see what the new arrangement looks like. Firms are worried about possibility of not being able to sell services freely throughout the European Union. New Prime Minister Theresa May wants to maintain passporting rights for U.K. banks, but EU members are seen as unlikely to make that concession without attaching the condition of free movement of EU citizens.
Blackrock’s Rupert Harrison, a former adviser to then Chancellor of the Exchequer George Osborne, believes the U.K. government will likely be forced to prioritize access to the single market over passporting rights because of its greater importance to the broader economy. “If banks are moving some of these jobs, I think that is entirely a rational thing to do for them,” Harrison told Bloomberg TV. “It is very hard to see a way to thread through this that retains these single-market access roles.”
Early 2017 has been cited as the most likely time for the British government to trigger Article 50 and begin negotiations for transitioning out of the EU, but the Sunday Times suggests that timeline could be delayed until at least later in the year as the U.K. finalizes its transition team.
RIDE-SHARING REVOLUTION TAKES GIANT LEAP
In the tech world, this week’s headlines were dominated, as they often are, by the ride-sharing and autonomous driving movement.
Uber announced its first fleet of self-driving cars will arrive in Pittsburgh later this month. And who will make the cars? Not Tesla or Toyota, but Volvo! The Swedish carmaker, remembered affectionately by millennials everywhere for its rear-facing station station wagon seat, has quietly become a major player in the world of automated driving technology. Uber signed a broader $300 million dealwith Volvo to work on building great self-driving cars. It also bought Otto, a startup focused on self-driving trucks.
Not to be outdone, Ford promised a fleet of driverless cars within five years.
As we noted a couple weeks ago, the ride-sharing world has become a tangled web of overlapping investors. “At least 11 companies or funds have invested in two or more of the biggest startups: Uber and Lyft in the United States, China’s Didi Chuxing, Grab in Southeast Asia and India’s Ola. The overlapping investors in part resulted from two mergers in China. Last year’s combination of two rival startups to create Didi, and the just-announced deal to sell Uber’s China operations to Didi, are uniting the three companies’ investor bases.”
NYU professor and valuations expert Aswath Damodoran thinks Uber is worth $28 billion, not $62.5 billion. “Disruption is easy but making money off disruption is difficult, and ride sharing companies would be exhibit 1 to back up the proposition,” he wrote in a recent blog post. Part of the reason for the lack of profitability has been a fierce price war, with a premium placed on winning market share. If ride-sharing consolidation continues, suddenly Uber’s pricing power equation looks a lot different. Lyft is said to be unsuccessfully seeking a buyer. Could a certain rival be interested at the right price?
JAPANESE PRIME MINISTER READY TO TRIPLE DOWN ON ABENOMICS
Conventional wisdom says Abenomics have failed. Attempts to debase have backfired, with the yen appreciating 14% against the dollar following the introduction of negative interest rates. This week the currency crossed back above the psychologically-important 100-yen level. Export data this week showed a 14% year-over-year drop, the worst since the financial crisis. Equities have also underperformed despite the Bank of Japan (BOJ) being on course to become the largest shareholder in the world’s third-largest equity market.
At its next policy meeting in September, the BOJ will conduct an assessment of its policy agenda. The outcome of that assessment would seem fairly obvious. But don’t tell that to Prime Minister Shinzo Abe. According to one of Abe’s economic advisors, Etsuro Honda, the issue is “not enough” rather than “too much” unconventional monetary accommodation.
FED TALK OF RATE RISE ON AGAIN
The Federal Reserve’s stochastic game of “will they” or “won’t they” continued this week, with July’s meeting minutes and public comments from regional Fed presidents reflecting the rate-setting committee’s resurgent confidence about tightening monetary policy later this year. Early in the week traditionally-dovish New York Fed President William Dudley said “it’s possible” to raise rates at the September 20–21 meeting following recent jobs and wage data, which could give rise to higher inflation. Atlanta Fed President Dennis Lockhart, considered a centrist policy thinker whose views often align with committee consensus, also said a hike next month is in play.
Dudley’s comments Tuesday caused odds of a 2016 hike to edge higher and stocks to retreat. Fed Funds Futures now imply an 18% chance of a September hike, up from 9% at the start of the week, and 50% chance of a tightening by the end of the year.
‘FLASH BOYS’ EXCHANGE GOES LIVE
The IEX stock exchange officially opened Friday in what will be a phased-in launch. But not everyone is happy about it. Nasdaq threatened to sue if the SEC approved IEX’s application, saying the proposed speed bump would add complexity to the market and have unintended consequences. The SEC approved it anyway, but Nasdaq isn’t suing. Instead the exchange is taking a more level-headed approach, deciding to innovate rather than litigate. “Clearly with the SEC’s willingness to approve IEX, we said, ‘OK, let’s be more aggressive in terms of what we might ask for,’” said Nasdaq CEO Robert Greifeld.
Nasdaq is seeking approval for a new order type called “extended life” which would move ahead of other orders if they agree not to cancel their orders for approximately one second. This would reduce the volume of cancellations, deemphasize speed and make liquidity more true and reliable.
QUOTE OF THE WEEK
“However they conduct the assessment, there is already an answer: Monetary policy hasn’t been eased enough … what we should say is, ‘Effects are diminishing, so let’s do more.’ This is the spirit of Abenomics.”
- Etsuro Honda, economic advisor to Japanese Prime Minister Shinzo Abe, on the Bank of Japan’s (BOJ) upcoming policy assessment
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