By Colin Cieszynski, CFA, CMT, CFTe, Chief Market Strategist, CMC Markets Over the last several months, concerns have been growing about China’s ability to remain the world’s primary driver of new demand for commodities, as its economy has slowed. Manufacturing PMI reports for China have fallen under 50 into contraction territory in recent months as seen below:
October 51.1
November 50.8
December 50.3
January 50.1
February 49.8
March 49.9
March Flash 49.2
Source: Bloomberg L.P., Markit Economics Slowing demand from China has impacted commodity prices as it has raised questions where demand may come from in future and exacerbating oversupply problems in some markets. For 2015, the government has already lowered its GDP objective to 7.0% from 7.5% and there have been questions as to whether the country will even be able to reach that target. PBOC hits the Panic Button? An even stronger sign of potential trouble in the Chinese economy has been the more aggressive easing actions undertaken by the People’s Bank of China in the last few months. The PBOC does not have scheduled monetary policy announcements so all moves are surprises by definition, but it has been acting more frequently lately signalling a growing concern about the economy and a stronger interest in trying to boost growth. The PBOC has used several tools to ease monetary policy in the last few months. It cut its 1-year lending rate from 6.00 to 5.35% over two moves in November and February. Also in February it cut bank reserve requirements by 0.50%, cut the deposit rate and into March, it has been trimming back the 7-day repo rate. In Q2 we should get a better idea of whether the PBOC is done or if it needs to undertake further easing to get the economy going. While cuts can spark short term knee-jerk position reactions on stimulus expectations, these often unwind quickly as traders recognize that the more aggressive or frequent the PBOC acts, the weaker the underlying Chinese economy may be. What does the China slowdown mean for commodity markets? Copper, with its wide range of applications has long been seen one of the commodity markets most sensitive to swings in Chinese demand. Similarly, among agricultural commodities, rice may be more sensitive to demand from Asia and emerging markets than say wheat, corn or soybeans. Comparing copper and rice with WTI crude oil shows some very interesting trends: First, all three markets started declining last spring as traders became more concerned that China could be slowing down. Second, while copper’s decline has attracted quite a bit of attention, its drop has been relatively moderate compared with rice and oil. Third, since the end of September, crude oil’s selloff has intensified dramatically relative to other resource markets. This shows the impact of the market share war among suppliers has come at a really bad time deepening the downtrend that was already in place and causing the price to crater. Finally, since the end of January, all three markets have stabilized. Copper and rice have actually started to recover a bit but it remains to be seen if this is more due to a correction in USD whose rally had depressed commodity prices, or a sign that traders are starting to speculate the PBOC’s easing moves could help the Chinese economy to recover. Source: CMC Markets Focus Charts: How has the China slowdown impacted stocks and currencies? The chart below, which shows how the USD has appreciated relative to other currencies is quite interesting. For years, there have been complaints that China was manipulating its currency to its advantage relative to the US and others. In the last year, however, when USD has soared against other major currencies (look at how it has skyrocketed against JPY alone) CNH has been rock steady against USD fluctuating within a 2% band. Considering how much China’s economy has weakened one would have expected a free floating CNH to have fallen against USD at least as much as SGD, which has turned in a middle of the road performance falling 10% less than JPY’s 20% drop but more than CNH which is essentially flat on year. In this quarter we may see whether China plans to allow its currency to depreciate as its peers have or not. The PBOC certainly has shown lately that it has other tools at its disposal, and may decide to keep the currency where it is for other reasons such as building confidence in its currency or avoiding more threats from US politicians. Source: CMC Markets China’s slowing economy has also impacted trading in the Hang Seng. After rallying last summer in tandem with its peers, the Hang Seng has levelled off since October failing to match the huge advances made by Japan’s Nikkei or India’s Nifty Fifty. On the other hand, it has outperformed Singapore’s Straits Times Index which has been steadily climbing since October but at a more moderate pace than the other indices in the chart below. This underperformance reflects that traders have had higher expectations for Japan on the back of its big ongoing QE program and in India on hopes the Modi government will deliver on much needed reforms. Although the PBOC has started to step up to the plate, it still appears the street is seeing it as being more cautious in its approach than the Bank of Japan. Should the PBOC continue to act more aggressively, or if the Chinese economy starts to improve the Hang Seng appears to have lots of room to catch up. On the other hand if the economy continues to stagnate and the PBOC stands pat, the Hang Seng may continue to trade sideways. Traders note that the Hang Seng’s current range is about 3,000 points 22,400 to 25,400 so even a sideways market may present significant opportunities to take advantage of shorter-term swings. Source: CMC Markets For information on how the weakening Chinese economy could impact Australia's economy and dollar, check out "Slowing China is a double threat to Australia" By Michael McCarthy CMC Markets is an execution only service provider. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.