China’s economy helps salve N Korea angst

14-Sep-2017 Intellasia | FT | 6:00 AM Print This Post

Its economic strength has helped markets shrug off regional tensions

In the current stand-off between North Korea and the US, China plays a pivotal role for investors.

As Donald Trump ratchets up the pressure on Chinese president Xi Jinping to strangle the economic life out of its neighbour, the country is key in helping to explain why markets have appeared relatively unperturbed as the rhetoric between the US administration and Kim Jong Un, the North Korean leader, remains bellicose.

South Korean equities, for example, remain buoyant and have risen almost 20 per cent this year. The Korean won has proved stoical, climbing more than 5 per cent against an admittedly supine dollar this year.

This disconnect between the politics and the markets is particularly vivid in the foreign-exchange market. A broad measure of the US dollar has fallen 10 per cent this year, touching its lowest in almost three years it should be a beneficiary of the North Korea tensions.

Even more puzzling is the Japanese yen’s appreciation of about 6 per cent so far this year. Markets seem to have set aside the pictures in local papers of Japanese school children cowering under their desks during drills in the days after a missile fired by their pugilistic neighbour crossed over the country.

The seemingly quixotic reaction in currency markets to the nuclear threat from North Korea comes alongside sustained buoyancy in global stock markets, with the S&P 500 in New York hitting another record close this week. And China offers a plausible explanation for the lack of nerves.

The renminbi has gained almost 7 per cent against the dollar this year, and has appreciated 3 per cent against the greenback in the past two weeks alone. Conventional thinking suggests that this is really down to dollar weakness. But perhaps the argument that renminbi’s rise reflects the continuing strength of the Chinese economy is actually more compelling.

Although the gains of the renminbi partly reflect Beijing’s tightening of capital controls, the fundamentals of the economy are stronger than elsewhere in the world and, importantly, owe nothing to irresponsible monetary policies. The Chinese economy expanded at a 6.9 per cent annual pace in the second quarter.

Despite those capital controls and massive levels of corporate debt, the renminbi is becoming a more attractive currency, given China’s solid growth, widening interest rate differentials, and progress on slowing the accumulation of debt at Chinese companies.

Of course, the sharp reversal in mood towards China at least compared towards the gloom and fears for the economy that dominated at the start of the year is not the only factor helping risk appetite overcome North Korea fears, as well as explaining movements in currencies.

The dollar has been hurt as expectations for further rate increases from the US Federal Reserve recede. Half of all market participants, for example, believe that the next Fed rate rise won’t be until September 2018 and others believe the US central bank will hold fire until the end of 2019. That retreat in expectations has done little to hurt the equity market.

With little sign of an acceleration in US inflation, the gap between when markets believe the Fed will raise short-term rates and the central bank’s own projections will probably widen. “The persistent disappointments in inflation have brought renewed concern from numerous Fed speakers in the past few weeks, [which] included a soft labour market report and an undershoot on average hourly earnings,” according to economists at JPMorgan. Investors understand better than the Fed that technology and the sharing economy are fundamentally deflationary and that wages are not about to pick up, even as unemployment falls.

Some residents in Seoul are currently decide where best to head to take a break from the city. Not to avoid a potential missile threat, but to observe 10 days of holidays that begin on September 30. Everyone will be hoping that the tensions of the past month begin to unwind and China may yet play a key role.

For markets, the steady performance of the Chinese economy will continue to provide better news for investors from the region.


Category: China

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