Recovery hopes rising in China

Economic data over the past month has been a mixed bag with news out of the euro area pointing to more downside risks to growth, while recession fears have eased somewhat in the US. In China investor confidence got a big boost from a strong stimulus package.

The disappointing news in the euro area came mainly from September PMI’s, which showed a big drop in both manufacturing and services. The employment components also indicated that the labour market may finally give in to the weak demand, which suggests the unemployment may finally start to increase from the current low levels. On the inflation front, September provided some relief with a downward surprise in headline inflation to 1.8% y/y and thus below the 2% target. Core inflation is still at 2.7% but the good news was that the monthly momentum in prices showed some cooling after a longer period of stickiness. Based on downside surprises to both growth indicators and inflation, we now expect the ECB to cut rates again already this month. We expect ECB to revert to quarterly rate reductions of 25bp after that.

When it comes to the US, recession fears have eased somewhat over the past month as consumer data has remained resilient and the savings rate was revised quite a bit higher. The latter dampened concern that consumption growth might be heading for a hard landing due to a reversal of a low savings rate. Focus remains a lot on the labour market after some months of cooling but the data so far for September did not point to further cooling. Inflation is still well behaved in the US and no longer a concern for the Fed. After they cut rates by 50bp at the September meeting, they signalled a more gradual easing path from here with 25bp cut per meeting, which is in line with our expectations.

In China the big news has been the announcement of large-scale stimulus across a wide range of areas. Lower interest rates, a reduction in the reserve requirement ratio for banks, lower mortgage rates on existing loans and measures to lift the equity market were among the policy initiatives. China’s leadership in the Politburo also sent a strong signal that the decline in the housing market should come to a halt now and sent a clear pro-growth signal after some years of more moderate signals and stimulus. The news has sent offshore Chinese equities sharply higher with an increase of 25% in seven days, the biggest 7-day increase since 2008, as investors have scrambled to close underweight positions in Chinese equities. The jury is still out if the stimulus will be big enough to turn the crisis but with the strong policy signal, we expect more stimulus to be rolled out if needed. We now expect to see a gradual improvement in Chinese housing and private consumption growth over the next year and that the two sectors will slowly put the economy on a more solid footing.

On the geopolitical front, the conflict in the Middle East has escalated further after Israel has launched a wider attack on Hezbollah in Lebanon and Iran launched a missile attack on Israel on 1 October. Until now, it has had limited impact on oil markets, and markets in general, but oil prices have started to move higher lately as the risk of a wider escalation is rising. Before the latest escalation, oil prices were edging lower as Saudi Arabia signalled increases in output to regain some of the market share lost to not least US shale oil producers over the past year.

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