Monday digest

Posted 11 December 2023

Overview: Commodities send a soggy signal
After a gangbusters November for global capital markets, December is also currently on a positive track with trading volumes higher than November’s averages generally, suggesting quite a bit of capital is being put to work by investors.

Global bond yields have fallen yet again (meaning bond prices have risen), driven by fears of slowing global growth. Economic data has been mildly soft, while energy and commodities have been weak. European bonds outperformed following dovish noises from members of the European Central Bank (ECB).

Economic data showed soft (but not awful) purchasing manager survey indices, offset somewhat by US mixed employment data. In the US, the job agency ADP’s November employment report weakened but Friday’s US employment report surprised economists by showing 199,000 jobs were added in November, a reasonable level of job creation paired with a very surprising fall in the unemployment rate, down to 3.7% from October’s 3.9%. Still, rate expectations have fallen because the policy setters at the US Federal Reserve (Fed) appear be more focused on inflation declines than worrying about what level of unemployment is too low for comfort. Nevertheless, bond investors had expected the US unemployment rate to worsen to 4% at least and November’s data does not support the case for any rate cuts without some other factor impinging.

But it seems bonds and equities are taking more of a cue from commodities and energy.

Equities ended the week back up to recent highs, with the US ‘Magnificent Seven’ bouncing back from fears about their exposure to softer consumer demand. Stocks had seen softness despite falling bond yields, as investors started to worry that earnings prospects may be challenged, with oil sending quite a weak growth signal.

Last week, we said how OPEC’s inability to act as bloc had led to ineffective supply cuts. Since then we have seen more oil price falls, and in addition, global industrial metals and agricultural prices moved down. They are less volatile than energy prices (mainly because energy stores are always relatively low compared to ongoing use) so the lesser decline is still significant. Commodity prices are still higher than they were 2021 but the decline from mid-2022 is clear. In the past 15 years, the biggest demand swing has emanated from China and there are all sorts of signals that the world’s second-largest economy is not providing the growth leadership that the largest economy in the world has given us.

With COP28 coming to a close at the weekend, the discussions have been neither a help nor a hindrance to asset and commodity prices, nor perhaps should they be, although COP28 president Sultan Al Jaber took the opportunity to swing the debate towards responsible fossil fuel policies. Ultimately, progress on dealing with emissions will be in the enactment of detailed policy, so perhaps this is good news. The conference also turned its attention to the loss of the natural world, which many think is a good refocusing.

Moody’s weighs in to add to the Chinese gloom

November was the continuation of a miserable year in Chinese markets, where economic and policy disappointments have been the defining feature. At the time of writing, the CSI is down 12.5% year-to-date in renminbi terms, while the Hang Seng has dropped a painful 18.3%. Weaker-than-expected growth and trade – compared to admittedly high expectations – has been the root of China’s issues for some time. The government has repeatedly tried to counteract this with various support schemes or political pronouncements – to varying degrees of success.

Last week brought another headache for Beijing, after ratings agency Moody’s cut China’s credit outlook to negative. Moody’s pessimism extends to both government and private banking debt – both of which are feeling the pressure from an extended property market downturn. Moody’s has only changed its outlook on Chinese credit, and a slight downgrade is unlikely to affect China’s medium-term borrowing capacity in a big way. That said, the news is clearly not a good thing for the Communist Party government and financial stress has been worsened by the exodus of foreign investors from Chinese markets this year.

The Chinese Politburo met last week to avow a significant fiscal push next year. Among the policies being swung into action, the People’s Bank of China (PBOC) has introduced something that looks very much like quantitative easing (QE), or the buying of bonds. This policy can work in different ways but one of its possible implications is that financial market liquidity improves, which can then feed through into rises in risk asset prices. The lack of foreign equity buyers has generated much comment but the similar lack of domestic equity buyers has also been notable.

Chinese consumers are feeling pessimistic to, and for good reason: 8.5 million of them (around 1% of the total working-age population) have defaulted on debt payments since the start of the pandemic and been blacklisted by authorities. As well as severely constraining China’s domestic demand – a side of the economy Beijing avowedly wants to foster – struggling consumers cannot pay taxes, hence reducing the government’s funds and worsening its fiscal metrics. All of this puts the Party in a precarious position.

This weakness is surely one of the main reasons China has been so conciliatory toward the west in recent months. It is hard to see President Xi’s meeting with President Biden last month – his first visit to the US since early 2017 – as anything other than a big peace offering. Trade tensions between the world’s two largest economies may well continue, but they are likely to be pushed much more by Biden than Xi. For the global economy at least, conciliation is a positive. But for China, its underlying weakness seems worryingly hard to address.