Calling China Bears: You May be Watching the Wrong Rates – and Country

Ask most commentators what’s behind this year’s emerging market rally and they’ll spit back in unison: the Fed.

Think again.

While the US Federal Reserve has in essence done nothing different all year, a larger central bank has been positively hyperactive. The People’s Bank of China has flipped from severe monetary tightening last year to saturating the markets with credit through 2016.

The PBOC’s $4.2 trillion balance sheet – dwarfing the Fed’s $3.7 trillion – dropped around 15% below its normal trend last year, according to data compiled by Crossborder Capital, a firm that analyzes global money flows.

“That – for the biggest central bank in the world – is a very significant tightening,” Michael Howell, Crossborder’s Managing Director, tells me in an interview this week. “Not surprisingly, the Chinese economy hit the skids. And not surprisingly, emerging markets crashed.”

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Now, however, we’re seeing the reverse from the PBOC. Its balance sheet this year is growing by between 5 and 7%, according to Crossborder. And it’s this effect, rather than the Fed keeping US rates near zero, that has fueled the rally in emerging markets, says Howell. 

Helicopter Xi

“Just take a look at Brazil, which has been the strongest market this year among the major emerging market countries. The trigger was an easing of Chinese monetary policy at the beginning of the year. Brazil has been catapulted higher ever since.”

Yet, it’s a correlation that “most analysts missed because they looked wrongly at interest rates,” argues Howell. Last year, “the problem in China was financial deregulation, which caused interest rates to drop. But behind that, money flows were moving in a very different direction.”

Now, things are better aligned.

“If you want evidence of helicopter money, believe me, it’s happening in China. They’re using money to finance fiscal spending.

“The main goal of the Chinese administration is to create growth, and one of the things that President Xi is aiming at – which is sort of carved in stone – is to make China a middle-income country by 2020, and they will achieve that. Therefore, the People’s Bank has to keep on easing monetary conditions.”

Faster growth

While China’s authorities will need to tame speculative bubbles through controls on markets such as tier-one housing, the overall economy will pick up in the months ahead. Xi’s economic growth target of 6.5% looks unattainable but the pace is still set to accelerate, from 2-3% now toward a 4-5% trend. And just as China’s growth starts accelerating, the US will fall into a mild recession in the early part of next year, Crossborder predicts.

Yet, whatever happens with America’s economy, elections and Fed policy, prosperity in the rest of the world will depend much more on China, according to Howell. That’s because the world’s second largest economy is the biggest trading partner for about 120 countries worldwide; the US is more significant for just fifty.

Global investors will respond to Chinese stimulus by continuing to channel money back into emerging markets, according to Crossborder, which predicts average 20% gains for developing nation assets this year and next.

“Emerging markets have been under a cloud for five years now,” says Howell. “Almost every institutional investor that we know is underweighted in the asset class, and they’ll have to move overweight. Basically, what you are likely to see in 2017 and beyond is very clear evidence that the emerging countries are starting to grow again at a faster rate than the developed world.”


Click here to listen to my full interview with Michael Howell along with Ravi Rajani, Business Development Manager for the real-time smart search engine Krzana

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