Daily Comment (July 17, 2017)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] It was another quiet weekend.  Here are the news items we are tracking this morning:

China economy:  GDP, somewhat predictably, came in a bit stronger than expected, at 6.9% (y/y%).   It’s important to remember that China can generate any growth number it wants as long as it has debt capacity.  Total social financing, the broadest measure of lending, rose 14.7% in June (y/y%).  Recent media reports indicate that the housing boom is exhibiting signs of overheating;[1] we noted that property investment rose 8.5% in H1, above last year’s 6.9% rise over the same period.  Orders from Chairman Xi to the State Owed Enterprises (SOE) to reduce their debt levels does suggest that the Chinese leadership is aware it is creating a debt problem.  The tradeoff, however, is daunting; it’s about impossible for China to grow at the above rate and simultaneously deleverage.

Xi prepares for October:  The PRC holds its annual leadership meetings in late October and this is a special one because it will announce Chairman Xi’s nomination for a second term.  Over the weekend, the party announced that Sun Zhengcai was being replaced as Party Secretary of Chongqing.  Sun was considered a possible successor to Chairman Xi in five years so removing him from power and indicating he is under investigation (effectively ending his political career) at least allows Xi more power in building his own Standing Committee of the Politburo and may be an early ploy to give Xi a third term which would be the first chairman to have more than two terms since Mao.  In the Chinese political system, the second term is usually the most important for a leader because in the first term, his rivals usually pick some of the members of the Standing Committee to maintain their influence.  In the second term, the chairman gets more leeway in building his own Standing Committee.

ECB, BOJ meet this week:  We don’t expect any surprises from the BOJ.  Market speculation suggests that ECB President Draghi will try to ease expectations of policy tightening by signaling the pace of balance sheet reduction will be very slow.  Although we don’t disagree with this goal, we do have doubts that Draghi can pull it off.  As former Fed Chair Bernanke discovered, once markets become fixated on easy policy forever, even the most modest of stimulus withdrawal can have surprising effects.  With Eurozone interest rates still negative in some countries, any hint of tapering will likely be a factor; we believe the most sensitive asset class will likely be forex, meaning any signal of tightening will appreciate the EUR.

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[1] https://www.nytimes.com/2017/06/15/opinion/chinas-real-estate-mirage.html