The Daily Prophet: Markets Catch a Small Case of China Fever

Something unexpected is happening on the way to China’s supposed hard landing: It’s attracting some A-listers who say the worst is over for the world’s second-largest economy. Instead of poking holes in the first-half growth numbers released last week as they usually do, economists have responded by raising their forecasts.

China’s gross domestic product will expand by 6.7 percent from a year ago in the third quarter and 6.6 percent in the fourth quarter, according to the median of 57 economist estimates in a July 17-24 Bloomberg survey released Tuesday. Although both forecasts are just 0.1 percentage point higher than a month ago, it’s the direction that matters. Count KKR & Co. as a believer. “China has already had its crash, per se,” Henry McVey, the global private equity firm’s head of global macro and asset allocation, said on Bloomberg Television. Caterpillar Inc. raised its sales and profit forecasts Tuesday, thanks largely to construction in China. Don’t sound the all-clear just yet, as China still has a massive debt pile that needs reining in, but the recent data and slowdown in capital outflows suggest global markets may soon have a surprising tailwind.

In fact, some investors and strategists say it’s already happening. Copper headed for its highest close in more than two years and shares in producers of the metal rallied amid expectations for increased demand in China, the world’s top user of industrial metals. Oil is headed for its first monthly gain since February after the Chinese Caixin manufacturing PMI for June, released July 2, also rose for the first time since February. “The expansion in the second quarter is a positive sign, as it highlights the resilience of China’s economy in the face of Beijing’s efforts to curb excessive borrowing to diffuse financial risks,” Carlos Casanova, an economist at Coface in Hong Kong, wrote in a research note. 

Copper surged as much as 3.4 percent, leading gains on the London Metal Exchange, as base metals extended a rally in the past month brought on, in part, by economists having become more upbeat about China’s economy and eased concerns about a tightening of liquidity in the country, according to Bloomberg News’ Mark Burton and Susanne Barton. Copper for three-month delivery rose 3.3 percent to $6,225 a metric ton on the LME, the highest closing price since May 2015. All main industrial metals climbed, while steel and iron ore contracts also advanced as the People’s Bank of China said it will pursue stable monetary policies. It’s not all about China, of course, as the weaker dollar has helped by making commodities priced in greenbacks more attractive. A rebound in China’s construction sector will be particularly beneficial for zinc, which is used to galvanize steel, while nickel has also benefited from signs of a rebound in stainless-steel demand, according to Casper Burgering, senior sector economist at ABN Amro Bank.

There’s also no shortage of strategists tying oil’s rebound at least partly to what’s happening in China, where data Monday showed crude imports rising 13.8 percent this year through June. Oil prices on Tuesday rose to the highest level in almost seven weeks, as Saudi Arabia pledged deep cuts to crude exports with supplies in the U.S. seen declining, according to Bloomberg News’ Jessica Summers. Futures advanced as much as 3.3 percent in New York. Saudi Arabia will cap shipments at 6.6 million barrels a day in August, 1 million lower than a year earlier, Energy Minister Khalid Al-Falih said. In the U.S., crude, gasoline and distillate supplies are expected to show a drop in the next Energy Information Administration report, due Wednesday. “Things are looking a little bit better” for the bulls, said Michael Loewen, a strategist at Scotiabank in Toronto. “If we continue to see demand do well and some refined products draws in gasoline and distillates, the market should perform pretty well.”

It wasn’t a very good day in the bond market, where the benchmark 10-year Treasury note fell the most in a month. Many traders pinned the move on some bullish positions being taken off after the recent rally rather than a sign of what they expect the Federal Reserve to say when it releases its latest decision on interest rates Wednesday. For that, perhaps it’s better to look at the results of the Treasury Department’s auction of $26 billion in two-year notes. Investors put in bids for 3.06 times the amount being offered, the highest so-called bid-to-cover ratio for that maturity since 2015. There are two ways takeaways, according to Peter Boockvar, chief market analyst at The Lindsey Group. The first, he wrote in a note to clients, is that the results reflect little belief that the Fed is going to be raising rates anytime soon. The second is that it suggests bond investors expect only modest economic growth and inflation that is stuck well below the Fed’s 2 percent target. Next up is the Treasury’s auction of $34 billion of five-year notes on Wednesday, followed by the sale a day later of $28 billion in seven-year notes.

The S&P 500 Index rose to a another all-time high Tuesday, as traders looked past disappointing results from Google parent company Alphabet Inc. and instead focused on decent earnings from companies such as Caterpillar Inc. and McDonald’s Corp. If anything, the rally just underscores that time is running out on the second-longest bull run in stocks on record, which will end by late 2018, when U.S. credit markets also will enter their first bear market since the global crisis, according to a Bloomberg survey of 30 fund managers and strategists on four continents. The would-be end of a great cycle for financial markets would come just about when central bank balance sheet contraction is expected to kick into high gear. By mid-2018, the Fed wind-down may be well under way, and the European Central Bank might have joined the Bank of Japan in tapering asset purchases. While none of the respondents signaled a 2007-09 style meltdown, even smaller-scale downturns have wreaked large-scale damage in the past, according to the Bloomberg News report. The 2002 bear market in U.S. stocks wiped out more than $7 trillion of value.

By all accounts, the Fed’s monetary policy decision Wednesday will be a nonevent — at least when it comes to interest rates. All 83 economists surveyed by Bloomberg News expected the central bank to keep its target for the federal funds rate in a range of 1 percent to 1.25 percent. Where things get interesting is the tone of the statement by the Federal Open Market Committee announcing its decision and what is said about the plan to start shrinking the central bank’s $4.5 trillion balance sheet. According to the economists at Bloomberg Intelligence, the recent easing in financial conditions that is largely the result of the rally in equities will allow the Fed to maintain a stronger tightening bias than would otherwise be possible with inflation moving further below the central bank’s target of 2 percent.

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Dollar and Commodities Break Enduring Pattern: Shelley Goldberg

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What the Fed Will Do This Week — and Why: Mohamed A. El-Erian

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