Is China in trouble?

If China sneezes does the world catch a cold? What ever way we look at it, China continues to expand, this is in stark contrast with recessions being experienced around the world, but, at what cost? Despite the country not fully implementing existing stimulus measures, real-GDP growth fell to +6.1%, y/y in the 1st Q from +6.8% in 4th Q, the lowest growth rate on record. External demand is waning, only natural. However, China has to improve domestic consumption to sustain growth. With millions of migrant laborers and students unemployed, the fear of social unrest continues. It’s a fine balancing act that’s required for the world’s 3rd-largest economy. Are they up to the task before its all breaks?

The US$ is stronger in the O/N trading session. Currently it is higher against 13 of the 16 most actively traded currencies, in a ‘whippy’ trading range.

Forex heatmap

It looks like inflation is dead in the water after this weeks US data. CPI headline fell -0.4% last month from a year ago (that’s the first decline in 54-years), as both food and energy prices fell on the month while consumer weakness continues to reduce businesses’ pricing power. However, core-prices unexpectedly climbed +1.8% y/y. Medical, education and tobacco, attributed for most of the increase. Surprisingly energy prices fell -3.0%, m/m, erasing all of Feb.’s gains. Digging deeper, one notices that home fuel oil prices declined -7.7%, m/m, gas and electricity was down -1.4%. The real eye open was gas and motor fuel which fell -4.4%, m/m, despite higher monthly oil prices. Not unexpected, house prices declined -0.1% in March. New vehicle prices advanced +0.6% m/m, the 3rd-consecutive monthly gain. As analysts point out it’s in sharp contrast to the ‘used’ vehicle market where prices have fallen for the last year!

Not so bleak was the Empire State Manufacturing Index which showed that conditions in the district have improved considerably more than expected. This month’s print of -14.65, despite a contracting signal, was at a less rapid pace than last month’s record print of -38. The optimistic view being spinned by analysts is that the region sample of overall US manufacturing conditions. The biggies being the Philly Fed and ISM will be the ones to adhere-to.

Finally, the capacity utilization rate declined more than expected to 69.3% (which is the lowest on record). Last month’s print was a 1-point drop from Feb.’s revised print (79.3%). Despite any signs of recovery over the medium term, the enormous amount of spare capacity should keep pricing power under pressure across the board. Consumers will not and cannot absorb increases at this time. Digging deeper, one notices that motor vehicle production jumped +1.5%, m/m, but ex-motor and parts, production plunged -1.9% m/m (the 5th-consecutive monthly decline).

The USD$ currently is higher against the EUR -0.36%, GBP -0.44%, GBP -0.28%, CHF -0.33% and lower against JPY +0.66%. The commodity currencies are weaker this morning, CAD -0.29% and AUD -0.87%. The loonie managed to print its highest levels in 3-months yesterday, amid signs that the global slowdown may be moderating and the belief by some traders that the quantitative easing that’s expected to take place next week under Governor Carney has already being priced in. Expect China t reverse some of thoughts. The loonie seems to be getting ahead of itself, definitely the ‘donkey before the cart’, combined with option-related activity and the ability of the TSX to resist the downward pull of US equities contributed to the currencies gains thus far this week. Technical analysts believe that if the currency could penetrate the 1.2020-50 support levels, it opens the door for a 1.1875 print. This may be a tad optimistic ahead of next week’s monetary policy meeting (21st April). It seems to be a foregone conclusion that Governor Carney at the BOC will ‘flood banks with cash to halt the hoarding of capital and expand lending’. A quantitative easing method has seen currencies depreciate significantly when their governments started the program (BOE, BOJ, and Fed). However, its painful not to go with the hard!

The AUD continued its slide from its 6-month high’s for a 3rd-day on the back of China saying its economy expanded at the slowest pace in almost 10-years (+6.1% vs. +6.8%), thus raising concerns that the global recession will deepen and investors will avoid the riskier assets. For now, look for traders to continue to sell on upticks (0.7187).

Crude is higher in the O/N session ($50.02 up +77c). Oil pared its earlier gains in yesterday’s session after the weekly EIA reported that inventory levels had climbed once again to a new 19-year high. Crude stocks rose +5.67m barrels to +366.7m vs. an expected +1.76m, the highest levels since Sept. 1990. More importantly, demand destruction remains an issue with total daily demand averaging +187m barrels over the past 4-weeks, that’s down – 5.2%, y/y. Gas inventories declined -944k barrels to +216.5m, while distillate fuels (includes heating oil and diesel), fell -1.17m barrels to +139.6m. Refineries are operating at +80.4% of capacity, down -1.5%, w/w, and the lowest level in 7-months. The fundamental data is abysmal, this is once again an extremely bearish report supported by demand destruction, that being said the black stuff is trading inter-day focusing on equities, USD and inflation. Sooner or later, the market will wake up and rely on the fundamentals. OPEC for an 8th-consecutative month cut its forecast for oil demand this year; they lowered by -430k barrels a day to +84.18m. They expect demand in industrialized countries to fall even further this year, while developing economies are likely to see only minor growth’. They next meet on May 28th to review production quotas. Crude had started the week under pressure after an IEA report for this year shows that total global demand may fall to its lowest level in 5-years. This is very much in line with OPEC’s views. They expect consumption to fall -2.4m barrels a day to +83.4m, that’s a decline of +2.8% as worldwide GDP falls by -1.4%. Until we see inventories decline substantially and sustainable demand destruction, there will not be a sustainable price gain. Gold is little changed despite US inflation reports being somewhat being benign. With the threat of the IMF needing to offload 3500+ tons of the yellow metal, expect the market to sell on upticks ($892).

The Nikkei closed 8,755 up +77. The DAX index in Europe was at 4,548 up +1; the FTSE (UK) currently is 3,990 up +22. The 10-year Treasury’s backed up 3bp yesterday (2.80%) and are little changed in the O/N session. Treasuries remain better bid on pull backs as the Fed purchased $10.3b off-the-run US issues as part of its program to keep borrowing costs low (to date just under $55b buy-backs in 3-weeks). Weaker fundamental data combined with continuous buy-backs (today’s long dated TIPS) will in effect keep treasuries better bid at the moment. Expect traders to make the government pay up for off-the-run issues. With no ‘prices pressure’ evident in this weeks US data, the Yield curve should flatten.

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Dean Popplewell

Dean Popplewell

Vice-President of Market Analysis at MarketPulse
Dean Popplewell has nearly two decades of experience trading currencies and fixed income instruments. He has a deep understanding of market fundamentals and the impact of global events on capital markets. He is respected among professional traders for his skilled analysis and career history as global head of trading for firms such as Scotia Capital and BMO Nesbitt Burns. Since joining OANDA in 2006, Dean has played an instrumental role in driving awareness of the forex market as an emerging asset class for retail investors, as well as providing expert counsel to a number of internal teams on how to best serve clients and industry stakeholders.
Dean Popplewell