Will Chinese excess liquidity spare the Aussie?

Yvan Berthoux -  25 July 2019

Just when it seemed that China was set on a course of unremitting credit tightening, help has finally arrived. The uptick in credit growth and excess liquidity is modest and recent, but it brings welcome relief to its trading partners, not least Australia.  Excess liquidity in China has led movements in Australian house prices for the past 15 years. Moreover, the improvement of China’s credit impulse, measured as the annual change in the Total Social Financing (TSF), could also generate additional momentum for Australian equities over the next 6 months. To the extent that this external fillip stabilises the Australian markets, it may dissuade the RBA from more aggressive easing and protect the Aussie Dollar from rough treatment, but we doubt it.

One of the big challenges for China-watchers has been to isolate the impact of microeconomic policy changes – designed to clamp down on corrupt practices and protect the financial system from unstable funding schemes – from macroeconomic policy objectives. When the squeeze on the shadow banking sector (figure 1) was at its fiercest last year, it was tempting to believe that China’s credit tightening had morphed into a macro policy, but this seems not to be the case.

Figure 1:

Data source: CEIC

Recent credit data reveals a moderation of the shadow banking clampdown and a change of tempo in TSF. Figure 2 describes the rebound in excess liquidity (M1 growth minus industrial production growth) and the corresponding pick up in the growth of TSF (right frame).

Figure 2:

Data source: Eikon Reuters, Economic Perspectives

Figure 2 demonstrates the impressive correlations between Chinese excess liquidity and credit trends and the subsequent annual growth rate of Australian house prices. Earlier this year, we reviewed how much of an impact the negative momentum in the Australian housing market could have on the local economy, considering that many investors have tried to trade the reversal of a 30-year boom cycle. Tighter bank regulation, including more stringent macroprudential measures, and a significant slowdown in foreign investor demand were two important factors contributing to the two-year bear market we have seen in the Australian property market. Can the recovery in excess liquidity in recent months significantly limit the downside?

Figure 3 (left frame) shows that prices were down 7.7 per cent YoY on average in the 8 main capital cities in the first quarter, with Sydney and Melbourne leading the way, down 11 per cent and 10.5 per cent, respectively. Even though the sentiment on the housing market and Aussie banks is still extremely negative, we think that the recent rate cuts from the Reserve Bank of Australia (RBA) policymakers combined with an increase in excess liquidity in both Australia and China could limit the downside in house prices. Figure 3 (right frame) shows that our leading economic indicator, computed as a linear combination of price data and surveys, has deteriorated markedly and is now close to its 10-year low.

Figure 3:

Data source: Eikon Reuters, Economic Perspectives

As a consequence, the RBA started its easing cycle ahead of everybody in the G10 space as it has more scope to cut as compared to economies already running a ZIRP or NIRP policy. We concluded that a good way to express this conviction about the housing market was to short the Aussie Dollar against either the US Dollar or the Japanese Yen. Figure 4 (left frame) shows that the interest rate differential has been one of the main drivers of the exchange rate over the years, therefore lower rates in Australia should weigh on the currency in the medium term.

In addition, it seems that real (M1) money growth has bottomed in most of the economies, hence the recent increase in excess liquidity, computed as the difference between real M1 and industrial production, may limit the downward trend in house prices in the coming quarters. Figure 4 (right frame) shows that the Australian excess liquidity has been a good leading indicator (9-month lead) of house prices over time. Will the improvement in credit and liquidity conditions obviate further easing by the RBA? In the context of the US Fed’s declared intentions, this seems unlikely, but the bearish outlook for the Australian Dollar may be averted.

Figure 4:

Data source: Eikon Reuters, Economic Perspectives

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