Macro Signposts | 24 April 2024
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What's Behind This Year's Boost in Global Manufacturing?
This year we've observed a nascent reacceleration in global manufacturing purchasing manager indices. Global manufacturing and industrial production (IP) growth cycles have historically been correlated with interest rate cycles, due to the link with growth in private and public sector capital expenditures. IP's recent surge seems surprising given generally high global interest rates, plus the post-pandemic normalization in global goods demand. On the surface, this appears to raise the risk that global goods spending and capital expenditures can accelerate despite higher interest rates.
A closer look, however, reveals that activity in China, and specifically Chinese manufacturing investment stimulus, is likely driving a good portion of the recent IP growth. And while this has supported global commodity market demand, Chinese intermediate and final goods are hitting global markets at discounted prices, contributing to aggregate disinflation while also raising alarms about a glut of production.
Counterintuitively, the IP growth acceleration may be a precursor to more macroeconomic volatility, as protectionist trade policies, tariffs, and the potential for currency devaluation come to the forefront. With declining foreign market access, China may need to adjust its growth expectations (potentially bringing down global IP with it), or find new ways to fill the increasing output gap from its property sector recession.
So, is global growth accelerating?
Diving into the data, we conclude that the recent boost in industrial production likely isn't the start of a new surge in overall global growth. Indeed, investors and policymakers may need to prepare for volatility and perhaps deflationary pressures.
After aggregating global IP data, and decomposing the growth into regions and sectors, a few conclusions stand out:
Understanding China's industrial growth: Brace for volatility
Digging a bit deeper, the drivers of China's acceleration have caught the attention of Western policymakers – and not because growth is likely to spark more global inflation. Rather, concerns are about exported deflation, subsidized goods, and asymmetric market access, which will likely intensify trade tensions with the West.
Over the last two years, China's property sector has seen a substantial recession. According to official Chinese estimates, private real estate development is down cumulatively by around 30%. The severity of the property sector recession has been compared with Japan in the 1990s, which suffered a roughly 30% peak-to-trough decline in residential investment, and the U.S. in the late 2000s, when the housing market collapse drove residential investment down 60%.
However, there's a big difference between Japan and the U.S. then, and China now: Despite property sector woes, official statistics indicate that the economy as a whole is maintaining the government's official 5% growth target. How is that possible? It's possible because China has been stimulating other sectors to make up the difference. Specifically, we see three broad areas:
Potential broader implications of China-driven growth
We may see deflation, and more policy and political volatility. The acceleration in global IP is in large part due to China's strategy to fill an increasingly large output gap related to its property sector, with higher production of goods sold on global markets at discounted prices. Indeed, according to the Central Planning Bureau of Netherlands trade export price indices, Chinese export prices fell much faster than global average goods exports. As Western policymakers take actions to counter China's export-led growth engine, these deflationary trends could potentially drive broader macro volatility.
As discussed in our latest Cyclical Outlook, Europe has felt more of the impact of Chinese economic weakness and the associated central government strategy to combat it, given Europe's export exposure to Chinese markets as well as the flood of cheap renewable energy products and electric vehicles (EVs) that have largely saturated European markets. In response, Europe has launched investigations into Chinese products, and has moved closer to imposing tariffs on EVs, which would further reduce trade between these two major economies.
EM countries are also reacting. Chinese steel exports rose dramatically last year, as less domestic demand from residential fixed investment pushed producers toward global markets. The discount prices have spurred various EM economies, including India, Mexico, Chile, and others, to impose tariffs and anti-dumping duties. Countries such as Brazil and Thailand are considering other measures.
The U.S. has been more insulated from the impact of China's economic policies, but it's not immune – setting the stage for more trade-related volatility regardless of who wins the presidential election. Recent U.S. industrial policy, including the Inflation Reduction Act, sets minimum levels of domestic content for companies to qualify for green energy investment credits, limiting some of the pressure from China's renewables production.
However, U.S. policymakers are wary of heightened Chinese import competition. Officials are also raising tariffs on Chinese steel, and the Biden administration has reportedly reached out to Mexico to discuss whether it would block Chinese foreign direct investment as a means for Chinese producers to access U.S. markets through standing free trade agreements. Members of the Trump campaign have discussed taking more aggressive steps: revoking China's most favored nation status; increasing tariffs on Chinese imports to 60%, with a 100% tariff on EVs (plus a 10% tariff on all other countries' imports); and moving away from the U.S.'s long-standing strong dollar policy.
Key takeaways: Uncertainty, volatility, and less trade
Our view is that investors shouldn't get too excited about the recent acceleration in global industrial production. It's primarily driven by China's reach for export led-growth, which has been a deflationary force in the global economy. It will also likely contribute to more macroeconomic volatility and uncertainty as nations with oversaturated markets react to heightened Chinese import competition by erecting trade barriers.
Eventually, this deflationary impulse could turn into an inflationary one, as higher tariffs offset some of the cheaper Chinese imports. And, in turn, with less access to foreign markets, China could struggle to reach its growth goals – and would seek new ways to keep its economy humming. It's no wonder that the prospect of further yuan depreciation has emerged. With higher tariffs from its trading partners, China may decide to allow some currency weakness in an effort to maintain global competitiveness.
Read the previous edition of Macro Signposts on signs of a tight U.S. labor market.
We welcome your questions about the global macro landscape. Don't hesitate to suggest themes or data for us to analyze and discuss: Please email [email protected].
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