China Readies Its Fiscal Bazooka

October 14, 2024

China Readies Its Fiscal Bazooka

  • China’s government promises to spend big but fails to offer any specifics.
  • The bias is for a stronger USD. Encouraging U.S. economic activity and sticky underlying inflation argue for a cautious Fed easing cycle.
  • There are no policy-relevant economic data releases today. U.S. bond markets are closed for Columbus Day holiday.

Please see our Drivers for the Week Ahead for an in-depth look at what markets are facing this week.

USD is firm against most major currencies and holding near a two-month high. Chinese stocks and iron ore future prices started the session trading on the defensive but managed to rise as much as 2%. In our view, the disappointing fiscal news out of China this weekend curtails upside momentum for risk assets and offers USD support. Importantly, the bias is for a stronger USD because there is greater room for an upward reassessment in U.S. interest rate expectations relative to other major economies.

US economic activity is strong and underlying inflation is sticky. The Atlanta Fed’s GDPNow model is currently tracking Q3 annualized growth at 3.2%. The next updated is due Thursday after the retail sales data which is expected to increase in September. Meanwhile, annual core CPI inflation (ex. food and energy) has been uncomfortably high between 3.2% and 3.3% since June. Fed speakers today include Kashkari (2:00PM and 10:00pm London) and Waller (8:00pm London).

In contrast, the Eurozone economy is stagnating and inflation is undershooting the ECB’s 2% target. As such, the ECB is widely expected to cut the key interest rate 25 bp to 3.25% Thursday. We also expect the ECB to reiterate that it “is not pre-committing to a particular rate path.” However, the risk is ECB president Christine Lagarde sounds dovish during her post-meeting press conference. 

U.K. growth momentum is sluggish and inflation pressures are easing. The slowdown in regular average weekly earnings growth (Tuesday) and CPI inflation (Wednesday) are projected to quicken in August and September, respectively. And Friday, retail sale volumes are forecast to decline in September due to unseasonably wet weather in England. The BOE is expected to resume cutting rates at the November 7 meeting while Governor Bailey warned earlier this month that the Bank could be a “bit more aggressive” in cutting interest rates provided the news on inflation continued to be good.

Japan’s economic recovery is unimpressive, underlying inflation is in a firm downtrend and most BOJ members view financial market as is still unstable. As such, the looser for longer BOJ policy stance is intact. Japan’s September CPI is the domestic highlight Friday.

In China, the economy is still struggling to escape a deflationary spiral. In September, CPI unexpectedly fell two ticks to 0.4% y/y (consensus: 0.6% y/y) and core CPI (ex. Food & energy) dropped two ticks to 0.1% y/y, the lowest rate since February 2021. PPI also fell more than expected to -2.8% y/y (consensus: -2.6%) vs. -1.8% in August, adding downside pressure to CPI inflation. To escape the debt-deflation loop, Chinese policymakers need to ramp-up fiscal measures to boost consumption growth.

On Saturday, China’s Ministry of Finance pledged again that more fiscal spending is in the pipeline but did not offer any numbers on new stimulus measures. Instead, Finance Minister Lan said the central government “has room” to raise debt and increase the deficit. In the meantime, Lan pointed out that local governments can tap funding from unused bond quota worth 2.3 trillion yuan by year-end. This is not fresh stimulus.

Lan also introduced broad set of measures aimed at reducing local government debt and stabilizing the property market. First, a one-time and large-scale debt ceiling increase will be introduced for local governments to swap their so-called “hidden” or off-balance sheet debt. Second, local governments will be allowed to use special bonds to purchase idle land from troubled developers or buy unsold homes and turn them into subsidized housing.

Detailed fiscal spending measures are expected to be unveiled later this month at a meeting of the Standing Committee of the National People’s Congress. The prospect of more aggressive fiscal stimulus measures from China should continue to support Chinese equity markets and growth sensitive currencies. But until the size and target of the additional fiscal package are clear, these assets are unlikely to see significant rise.

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