One Bank Asks: What Happens If The U.S. And China Both Roll Over?

Summary

SocGen is out with their latest global outlook note and they're concerned.

Specifically, they want to know what exactly you think would happen if the US and China both disappoint.

Spoiler alert: their prediction isn't pretty.

I read something interesting on Wednesday.

Actually, I read a lot of interesting things on Wednesday, but SocGen had a bit on "Trumflation" versus "Xiflation" that I thought was worth penning a quick post on.

If you kind of step back and think about what's going on in the US in terms of political turmoil hampering the Trump administration's ability to advance a growth-friendly policy agenda and then you juxtapose that with China's efforts to deleverage its financial system, you end wondering where the impulse for global growth is going to come from.

Remember these charts?

(Citi)

That is why you don't want the growth agenda to stall in the US at exactly the same time China's tightening efforts put the brakes on their domestic economy.

While the jury is still out on tax reform and fiscal stimulus in Washington, the market has already delivered its verdict, at least as far as the curve (NYSEARCA:TLT) and the dollar (NYSEARCA:UUP) are concerned:

(SocGen)

Yes, equities (NYSEARCA:SPY) are still alive, but as BofAML wrote on Wednesday, stocks are the last man standing and have diverged meaningfully from both soft and hard data:

(BofAML)

Now think about that in the context of the following charts that depict what's going on in China:

(Deutsche Bank)

See how credit growth is decelerating and the PMIs are rolling over (incidentally, the Caixin line would look even steeper if Thursday morning's print were included)? Yeah so that's at least partly attributable to the ongoing effort to rein in leverage and that effort has a lot further to run.

So the question becomes this: what happens to global growth if the Trump agenda doesn't pan out and China's economy falters? Well, here's SocGen's answer from a note out Wednesday (full piece here):

China has enjoyed a strong recovery in nominal GDP since early 2016 and with that also a sharp recovery in nominal exports and imports. Reflation policies combined with the recovery in commodity prices explain the bulk of this move. Renewed concerns about China's overreliance on credit, however, have triggered liquidity and regulatory tightening and we believe that China has already this spring entered a nominal growth slowdown. Although real growth is set to remain fairly stable over the coming quarters, the fact that China is shifting from reflation back in the direction of deflation is something we believe will matter both for global sentiment and trade dynamics.

The election of Donald Trump in the US boosted hopes of deregulation, tax reform and fiscal expansion. Hopes, however, have faded since the election and the latest developments with the investigation into the Trump campaign's Russia ties mean that even our own below-consensus outlook now comes with greater downside risks. Prior to the election, our call had been for the US economy to enter a cyclical downturn in 2H18. Without the modest tax boost (around 0.3pp of GDP) that we factor in, this risk scenario could well materialise.

Should tax cuts fail to materialise, the US economy could well lose momentum as early as 2H18. Mechanically, cutting 1.0pp from the US outlook would knock around 0.25pp off global GDP growth in 2018. Note, that if China were to suffer growth 1pp below our forecast, that would also knock 0.15pp off global growth. Our baseline scenario is for China to slow by 0.5pp between 2017 and 2018. To offset that, based on this simple calculation, the US must expand by an additional 0.3pp in 2018.

Make of that what you will, but it's yet another example of how many moving parts there are here.

It seems to me that with each passing day, retail investors are becoming more and more myopic in terms of thinking that all they need to watch to understand markets are US benchmarks.

That wouldn't be such a deleterious tendency under normal circumstances, but as you're probably aware, the geopolitical and market circumstances are anything but normal.

And speaking of watching benchmarks, what's wrong with this picture?...

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.