Straits Financial Chief Economist Commentary – November 2024

Chinese fiscal outlays leaped since September

Summary:

• Since September this year, with the introduction of various stimulus policies, China's fiscal outlays leaped, as the growth rate of fiscal expenditure and broad-based deficit has significantly accelerated. From August to October 2024, the net issuance of all government bonds in China reached RMB5 trillion.

• China’s Ministry of Finance revealed that the scope of LGB coverage will be extended, including the repurchase and demolish of shacky houses, government buyback of unsold houses for affordable housing, and the swap of shadow local government debts. We expect this will improve the domestic economic fundamentals, and the GDP in Q4 will recover to a growth rate of over 5%.

• On 5th of November, the dust of the US presidential election was settled with a Trump victory and GoP sweep. We think Trump 2.0 is more certain about three points: 1. Strengthening border control and restricting illegal immigrants. 2. Making 2017 corporate tax cut permanent and introduce further tax cuts. 3. Promoting government deregulation.

• Trump's return will also bring some uncertainty and negative effects. 1. Increasing US tariffs and restricting foreign competitive products from entering the US. This will affect  the global trade economy and supply chain stability as well as  driving up US inflation rate. As US inflation expectation and treasury yield has risen up to a very high level this year, this will have a negative impact on household debt interest rate, cost of government debt and the living cost in the US.

• The easing of the Chinese domestic policy may have little to zero impact to benefit the commodity markets, as this time the policy stance is to cut supply on the downstream industry and real estate, which is not benefitting the commodity prices.

• The "Trump Trade" is expected to continue. However, if the 10-year inflation expectation and treasury yield further increase by more than 30bps on the current basis before the end of the year, we suggest that we can consider taking profits on US stock market in the short term.

• There is still a possibility for the overall A-share market to rise again, but it will take time. 1. The market needs time to consolidate the high turnover rally. 2. The market needs to see more data on fiscal and monetary policy expansion. In the context where the market mainly relies on policy expectations and liquidity promotion, A-shares tend to speculate on small and medium-size cap thematic stocks.

Previous Views:

Trump is more likely to win the election. The tax cut he advocated is more favorable for the short-term outlook of the US stock market. Considering the need to maintain economic growth and local fiscal sustainability, we believe that September and October may be an important time window to observe whether Chinese government will introduce further unexpected stimulus policies.

Views in November:

I.                 Fiscal outlays leaped in September, and we expect Chinese GDP to rebound in Q42024

Since September, with the introduction of various stimulus policies, China's fiscal outlays leaped in September, as the growth rate of fiscal expenditure and broad-based deficit has significantly accelerated. In September, China's broad fiscal deficit was RMB2.09 trillion, far exceeding the same period last year. The cumulative broad-based deficits from January to September this year reached RMB6.83 trillion, surpassing RMB5.89 trillion in the same period last year (see Figure 1).

Source：Bloomberg，CEIC，Wind

At the same time, from August to October, the issuance of all government bonds in China also increased significantly (Figure 2). In three months, the net issuance of government bonds, including local government bonds (LGB), financial GSE bonds, and treasury bonds, reached RMB5 trillion. Therefore, this year's broad-based budget deficit can be fully guaranteed to reach RMB9 trillion.

Source：Bloomberg，CEIC，Wind

At the same time, the previous press conference of the Ministry of Finance also revealed that the scope of LGB coverage will be extended, including the repurchase and demolish of shacky houses, government buyback of unsold houses for affordable housing, and the swap of shadow local government debts, all of which will be included in the new scope of use of LGB. From 4th to 8th November, the Standing Committee of the National People's Congress also discussed the proposal to increase the LGB quota to swap for the shadow local government debt. We believe that there will be a significant increase in the issuance of LGB in the future. By the end of October, the cumulative amount of treasury and LGB issued this year had exceeded RMB9 trillion, exceeding the size of last year (Figure 3). However, in the next two months, we expect more than RMB1 trillion government bonds to be issued.

Source：Bloomberg, CEIC, Wind

In our monthly report titled “Investors still need to wait for more domestic fiscal stimulus” released in early September, we mentioned that September and October may be an important period to observe whether domestic policies will introduce further unexpected stimulus policies. At present, it is true that the government has made significant leaps in fiscal expenditures from September to October, which has also effectively promoted the sharp rise of the domestic stock market and the rebound of certain economic indicators, such as real estate sales and retail consumptions. We expect that with the further increase of domestic fiscal policy, it is expected to promote the continued recovery and improvement of the domestic economic fundamentals, and the GDP in Q42024 will hopefully recover to a growth rate of over 5%.

II.                How will Trump's victory affect the market?

On 5th of November, the dust of the US presidential election was settled. Republican candidate Trump defeated Harris and returned to the White House after four years. At the same time, the Republican Party also achieved a sweep in the congress election, winning both House and Senate majority. Trump's return to the White House will also bring many uncertainties to the future global economic development. However, Trump 2.0 is more certain about three points: 1. Strengthening border control and restricting illegal immigrants from entering the US. 2. As GoP controls congress majority, the Trump 2.0 administration will make its 2017 corporate tax reduction act permanent, and on the other hand, may promote further tax reduction, that is, the US corporate income tax will be reduced from the current 21% to 16%. In fiscal year 2024, the corporate income tax of the US is USD530 billion. If the tax rate is reduced to 16% as promised by Trump, the corporate tax will be reduced by about USD130 billion (Figure 4). In 2017, Trump's first term corporate tax cut act played an important role in promoting the rise of US stocks at that time. Therefore, as early as mid-September, when Trump was expected to win and even for GoP to sweep, the US stock market had started the rise of the so-called "Trump Trade". When the sweeping results of the Republican Party were announced, the rise of the US stock market further accelerated. 3. Trump's new government will promote government deregulation. This will be beneficial for the digital currency and financial industries. Therefore, Bitcoin also rose sharply driven by the "Trump Trade".

Source：Bloomberg, CEIC, Wind

However, Trump's return will also bring some uncertainty and even negative effects. First of all, Trump said that after taking office, it would significantly increase US tariffs and restrict foreign competitive products from entering the US, thus protecting American industries and employees. Although this commitment has won Trump more supports from the perspective of obtaining election votes, if implemented, it will significantly push up the inflation level in the US. Due to the current labor shortage and rapidly rising labor costs in the job market in the US, restricting foreign products from entering the country and relying on domestic production and supply chains will undoubtedly greatly increase the cost of domestic products, and further increases in domestic worker wages will also drive up inflation levels again.

Therefore, after the "Trump Trade" was launched, the inflation expectation index in the US market rose rapidly. With the victory of Trump's election, the long-term inflation expectation rose to the highest level this year (Figure 5). At the same time, the interest rate of the 10-year US treasury bond also rose again to 4.5%. This situation, if continues, will have a significant negative impact on the stabilization and rebound of the US economy. This is due to the fact that the US market interest rates, such as those of mortgages, car loans and credit card loans, are highly related to the treasury yields. Therefore, with the sharp rebound of inflation expectations, the treasury yields have also significantly pushed up the interest rates of American residents' debts, thus causing new adverse effects on household consumption. Secondly, the significant rebound in inflation expectations will also pose a certain obstacle to the Fed's interest rate cuts, making it more difficult for interest rates to fall back. The rising treasury yields will cause the continuous rise of the cost of the US government's debt issuance, which will further increase the pressure of the US fiscal deficit.

Source：Bloomberg, CEIC, Wind

At the same time, we also witnessed  a major factor causing the Democratic Party's debacle in this election is the extreme dissatisfaction of American people on the inflation caused by the massive fiscal stimulus in the past few years. This is especially true for people in low and middle-income families with less assets and people from inland states, who have benefited less from the rise in stock and housing prices, but their cost of living is rapidly increasing as well, leading to complaints about the Democratic government. Therefore, Trump's new government will face a dilemma in the future. On one hand, he wants to restrict imports by increasing tariffs, thereby increasing employment opportunities and wage levels in the inland manufacturing states. On the other hand, doing so will inevitably cause new inflationary pressures, which may lead to more dissatisfaction before manufacturing jobs come back to the US (if possible).

As an important ally of Trump's election, Elon Musk also said that Trump's new policy would include a substantial reduction in the current high fiscal expenditure of the US. Although Trump himself has not made a statement on this, the US stock market has so far totally ignored this scenario, but since Musk himself is likely to take an important position in the new Trump administration, it is not ruled out that the new Trump government will really cut fiscal expenditure in the future, which will create certain uncertainty risks for the US economy and consumer demand next year.

Therefore, we believe that the "Trump Trade" is only limited before Trump's inauguration at the White House (January 20, 2025). When Trump really takes office and begins to formulate his fiscal, trade and monetary policies, these contradictions will become more prominent and acute. Although Trump also promised to control inflation, the inflation control measures he talked about were mainly to remove the new energy and environmental protection policies of the Biden administration, and to significantly increase the exploitation of traditional energy such as shale oil, so as to reduce inflation by lowering the oil price. However, we know that the current inflation in the US is not driven by rising energy prices, labor costs are the more important part of it. If the overall import prices in the US rebound rapidly, coupled with further increases in labor costs, simply lowering oil prices cannot solve the inflation issue.

III.                Chinese domestic policy easing may have little impact to benefit commodity prices

The easing of domestic fiscal policy has also had a significant upward effect on commodity prices. However, compared to stocks, we believe that investors should be more cautious about the rise in commodity prices in the near future.

However, the current round of fiscal easing is mainly aimed at cutting production of and destocking downstream consumer goods and real estate. It is more important to reduce the production capacity supply of downstream consumer goods and real estate to solve the overcapacity and over-inventory problem, including real estate and new energy products. That is to say, the biggest difference is that the policy objective of this round is to stabilize the prices of end consumer goods and real estate by reducing supply, rather than further increasing the production of these products. Therefore, for more upstream commodities, there is no real increase in demand, or it may even lead to further decline in demand. Similarly, for many new energy products, the same theory applies. The government has explicitly required these industries with overcapacity to decrease production capacity and output, and to stabilize their product prices by reducing supply to reverse the domestic deflation situation.

In addition, Trump’s return has added uncertainty to China's exports next year. This is not to say that Trump will increase tariffs on Chinese export products in an all-round way. However, Trump is likely to restrict the export of new energy products from China, as well as the export of cars from Europe, semiconductors from Japan and South Korea to the US. In the context of deteriorating export conditions, Europe, Japan, and South Korea are likely to impose more restrictions on China's exports of automobiles and electronic products to their own countries to ensure that their own manufacturing industries do not suffer. This may have a serious impact on China's main export growth products in recent years, namely new energy, electronics, and automobile exports. Taking automobiles as an example, China's passenger car exports have accounted for 22% of total sales this year, and this proportion is still increasing. In 2020 in comparison, China's passenger car exports accounted for only 2.8% of total sales. Therefore, if the proportion of automobile exports cannot be further increased next year, it may significantly increase the pressure on domestic automobile production and sales, thereby forcing automobile manufacturers to reduce output. Therefore, for domestic commodities, it will also create new demand pressure.

Source：Bloomberg, CEIC, Wind

In summary, China's own industrialization and urbanization have little room to increase, and more international trade barriers and supply chain restructuring are imperative, therefore, from the perspective of domestic demand alone, even if policies of increasing fiscal spending to alleviate the pressure of real estate inventory and local government debt, it is unlikely that policy easing will significantly restart the expansion of overall domestic real estate investment and manufacturing demand.

IV.                Market strategy

The "Trump Trade" will be expected to continue after the GoP election sweep. However, the main risk is that it will promote the inflation expectation, and the treasury yield to rise again in the US. If the 10-year inflation expectation and treasury yield further increase by more than 30bps on the current basis before the end of the year, we suggest that we can consider taking profits on US stock market in the short term.

There is still a possibility for the overall A-share market to rise again, but it will take time. 1. The market needs time to consolidate the high turnover rally from previous large-scale market rush buying. 2. The market needs to see more data on fiscal and monetary policy expansion. In the context where the market mainly relies on policy expectations and liquidity promotion, A-shares tend to speculate on small and medium-size cap thematic stocks.

We believe that this round of domestic fiscal easing may have limited impact on commodity prices.