Global equity markets closed the week largely mixed after another period of heightened volatility. Stocks in the U.S. were just marginally higher as tech stock prices moderated while gains in developed ex U.S. markets were balanced against weekly losses for emerging markets. The yield on the U.S. 10-year treasury closed just shy of 3.2% and marked 23 straight trading days above three percent for the first time in over 7 years. The price of West Texas Intermediate crude oil dipped back below $70 per barrel as prices backed off their recent three-year highs and traders digested more Middle East geopolitical intrigue.
Chart 1: 10-Year moving higher…
China’s economy facing dual headwinds
A number of factors contributed to this week’s market moves, but China was a key contributor risk-off market sentiment this week as the National Bureau of Statistics reported that the country’s economy grew at its slowest pace (6.5%) since the height of the global financial crisis. We believe that growth in the Chinese economy is likely to continue slowing this year and into 2019 as Beijing deals with two key headwinds.
First, the slowdown this year was largely expected as policymakers had planned to implement key structural reforms to address high levels of debt in certain sectors of the country’s economy. To do so would have meant addressing overcapacity issues (like consolidating excess steel and concrete factories) and tightening lending standards to curb unchecked borrowing. These factors alone were likely to contribute to slower growth in the country’s economy as production and credit utilization eased. While expected, these reforms contributed to some market skepticism as the potential for policy mistakes (reforming too quickly) could slow the economy too fast.
A second, more prominent issue helped move China related concerns to the front burner in recent months and that is the increased tension between the U.S. and China which centered on the U.S. imposing a host of tariffs on China in a relatively short period of time. While both parties appear willing to reach a settlement on the recent trade impasse, negotiations are fraught with back and forth posturing and market participants are growing increasingly concerned that the longer U.S. imposed tariffs stay in place, the more potential damage to the Chinese economy.
Chart 2: Chinese economic growth slowest since 2009
Trade remains an important part of the Chinese economy as a notable size of its manufacturing and employment base are geared towards producing and exporting goods to the U.S. Therefore, a slowdown in manufacturing activity as a result of reduced trade demand from the U.S. has the potential to drag on broader Chinese economic growth. Data nevertheless suggest that manufacturing activity and trade remain expansionary but weakening trends in their growth are pointing to the contrary.
We view the weaker GDP print to be reflective of a broader cyclical downtrend in the Chinese economy. We believe that financial markets are likely to grow increasingly worried about China and its economy as more indicators begin to point to slowing, namely business sentiment as measured by the manufacturing and services Purchasing Managers’ Indices (PMIs) coupled with slowing trade activity. For now, policymakers’ efforts to revive fiscal and monetary stimulus efforts and Beijing’s attempts to vocally assuage public concerns about the U.S.-China trade dispute could help put a floor under the slowdown.
Looking to the week ahead, two key economic releases are likely to be top of mind for investors. The European Central Bank’s (ECB) governing council meeting on Thursday is likely to closely scrutinized by market participants to determine whether or not policymakers at the central bank are getting worried about Italy’s budget impasse, the impacts that its having on systemic financial risks but more importantly, the trajectory of ECB monetary policy.
The other important economic release due out in the coming week is the Bureau of Economic Analysis’ advance read on third quarter GDP growth. Consensus expectations put this figure at an expected growth rate of three percent. Nevertheless, anything marginally weaker or strong is likely to prompt negative market concerns as investors look for their concerns about an impending recession to be validated on the one hand and worries that the Fed may choke off growth prematurely on the other. Either way, we expect heightened levels of volatility to remain with the markets over the next few trading days.