Letter To Shanghai No 1152 - Changing shape

Earlier this morning, the Chinese National Bureau of Statistics released a document entitled "The National Economy Made a Good Start in the First Quarter." It contains an entire shopping list of positive statistics. This data will be extensively covered in tomorrow's People's Daily, but for now, I will give you only part of this comprehensive overview.

The important number is that GDP grew at 5.3% year-on-year, or up by 1.6% QoQ over 4Q 2023. Looking deep into the figures, most sectors improved; particularly, the value-added sector of high-tech manufacturing increased by 7.5%, 2.6% faster than in 4Q 2023. The investment in high-tech manufacturing and high-tech services grew by 10.8% and 12.7%, respectively. Indeed, production of electric vehicle charging facilities, 3D printing devices and electronic components increased by 41.7%, 40.6% and 39.5% year on year, respectively, which are massive improvements and the type of development that Beijing prefers to support.

The numbers indicate that this recovery has several tracks. High-tech, high-end manufacturing is improving while the housing market, house development, etc., is as best moving sideways to down, something we can see in the official house price index, which has depreciated -2.2% YoY, while the common consensus would suggest the depreciation is far higher than that.

With Domestic GDP now delivering Beijing's published policy target of around 5% for those in Beijing with their hands on the levers of economic control, there is no incentive to move those levers in any way at all. The big guns of interest rate cuts or RRR revisions will remain in reserve to be used if there is an exogenous shock to the economy later in the year.

It must be said that the economic recovery in China is not yet on a firm footing, and weakness can and may occur. But let us look at this a different way, what if the Chinese demand spigot continues to open up during the next 3 months? How much pressure will that add to stretched commodity supply lines, and what would be the impact on the US inflation numbers?

Either way, can you feel it? To me, it seems market expectations/consensus are being proved wrong every day. That is not because the various bank and hedge fund analysts have forgotten how to add up or manipulate their spreadsheets. It is because the underlying assumptions that they use to drive those spreadsheet models are being challenged. At the start of the year, the market consensus was for six US rate cuts; three months in, the market may see two, perhaps one, and there is a growing case that there may even be a single rate rise. A lot of recent trading is to let your computer look for the outlier, the mispriced asset versus some alternative benchmark. Therefore, arbitrage trading can be simplified to stretching an elastic band between both your thumbs and moving your hands apart. At some point, you may find a limit, but you always expect the elastic band to draw your hands back together again. And so it is with arbitrage traders - everything is fine when the invisible elastic band is working, but when underlying assumptions are broken, the elastic band breaks. Are we at that point now? Probably not yet, but these consistently missed expectations on important numbers are making me feel queasy. It would seem if not broken in some markets, then in other markets, the elastic band, the fundamental relationship, is changing shape.

Have a good day,

John