New heights - China Stress Index


Stress over China reaches new highs


 

Investor sentiment for China has plummeted. Our proprietary China Stress Index paints the picture…

NatWest Markets’ proprietary China Stress Index is used to measure investor sentiment towards China. Since Monday 5 August, the Index has continued to climb… What’s troubling investors?

Index hits new highs

So much for August being a quiet month for financial markets…

Since 30 July our China Stress Index (referred to as ‘the Index’) has soared – reaching new two-and-a-half-year highs (see Chart 1). And we expect this to continue in the near term.

From the lowest point of stress to the highest

So far, 2019 has been a year of two halves according to our China Stress Index. Between January and April 2019, the Index was on steady downward path, reaching its lowest point on 5 April. This didn’t last long.

Stress increased rapidly following the breakdown of talks between the US and China in early May. In response, the Index made a complete U-turn as investor stress towards China began to move in a steady, upward trajectory from mid-April onwards.

That said, the overall magnitude of the rise in investor stress seen between April and July can be considered as relatively subdued when compared to other periods. For example, in Chart 2 you can see that the Index spiked sharply between June and July 2019. For more case studies, read our previous post.  

However, if the Index continues to climb at the rapid rate is has since 30 July, it will be the most that the Index will have ever risen in a single period.   

Chart 1: NatWest Markets China Stress Index 2013-2019 

Source: NatWest Markets and Bloomberg, data as at 12 August 2019.

 

Chart 2: NatWest Markets China Stress Index: New 2.5-year highs since January 2019
 

Source: NatWest Markets and Bloomberg, data as at 12 August 2019.

Three triggers: Trump, Politburo and yuan devaluation

Market sentiment towards China was hit badly by three consecutive events, all of which contributed to the rise in the China Stress Index.

  1.  Trump’s shock tweets and tariffs

    Despite ‘constructive talks’[1] during the 30-31 July meetings in Shanghai between the US and China, Trump announced new tariffs via a shock tweet only one day later on 1 August. Proving the G20 trade truce in Osaka on 29 June was short-lived, 10% additional tariffs on the remaining $300 billion of Chinese goods were announced for 1 September.

    In his tweets, Trump also expressed frustration with China for not increasing purchases of US agricultural products fast enough and he threatened to raise the 10% tariffs to 25% (or beyond) in a ‘short period of time’.

    The unexpected timing and size of the new tariff threat surprised investors and global markets more broadly.

  2. Politburo meeting outcome – not what was expected

    The Politburo meeting statement published on 30 July outlined less action the market expected. The meeting prioritised sustainable and high quality growth amid increasing downside pressures; although, it did not include any language on deleveraging. It reiterated that China will not use the property market to boost short-term growth rates – a clear departure from old style, debt-fuelled stimulus. The statement also signalled more tolerance for a slower growth rate, with more emphasis on the quality of growth.

    Overall, the outcome went against the market consensus expectation and this hit investor confidence.

    We expect government policies will remain focused on targeted easing and reforms to stabilise growth rates. However, we don’t anticipate any additional aggressive stimulus coming through in the second half of 2019. Instead, we believe that real Gross Domestic Product (GDP) growth will gradually slow to 6.2% by year-end.

  3. Yuan devaluation – the first step towards a currency war?

    For some time now, China’s authorities have been deliberately bolstering their currency, keeping the yuan artificially strong. However, China’s authorities have now turned their back on this approach, causing concern for investors. 

    On 5 August, the People’s Bank of China (PBoC) allowed the US dollar to Chinese yuan exchange rate (USD/CNY) to break the significant level of seven. The market interpreted this move by the central bank as essentially letting go, devaluing the yuan in light of President Trump’s recent tariff escalation.

    There is no doubt that recent yuan weakness is a reaction to the breakdown in trade talks and Trump’s new tariffs threats. The questions we’re now asking is ‘are we on the brink of a currency war?’

Equities and commodities are playing a key role, too

These three events were key triggers in the shift in sentiment towards China and this had a big effect on the price of Chinese equities – namely the Shanghai Composite Index (SHCOMP). To put this into context, the fall in the SHCOMP attributed to around 45% of the rise in the China Stress Index during the first week of August.

Another key driver in the rising stress has been the drop in commodity prices (both Copper and Zinc).

Where will the China Stress Index go to next? UP

A safe haven for summer – Chinese government bonds

Against this complex backdrop, global markets have a low risk appetite. As such, demand for safe haven investments such as Chinese government bonds is rising, and therefore, returns (yields) on these investments are falling. The 10-year Chinese government bond yield is one of the six market indicators that make up the NatWest Markets China Stress Index. Therefore, it is likely that the Index will continue to climb higher as bond returns decline in the face of high demand.  

SHIBOR rates, another on the six market indicators for the Index, have risen higher. However, recognition of this has been overshadowed by the drop in Chinese 10- year government bond yields. We expect that lower-growth prospects expressed through lower long-term returns will push the Index higher still.

All in all, the picture remains uncertain. And the weakening of the Chinese yuan adds to the mix. In fact, almost all six components of the Index point to more stress. We will continue to use the China Stress Index to assess market sentiment in the wake of any developments.

Watch this space.

Where to view the China Stress Index

Anyone with a Bloomberg terminal can find the Index ticker by searching “.NWMCHSI G Index”.

Watch this space for more updates about how the Index performs over the coming months.

Thanks to Sukriti Kalra for her contribution to this article.

[1] According to the US-China trade negotiation teams


 

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14th August 2019

Author:

Peiqian Liu
China Economist,
NatWest Markets

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