Bond yields, China’s “failure’ of policy, and Nvidia’s march higher

This is a big week for those who like to listen to central bank talk. The Jackson Hole Symposium runs from 24-26th August, and the title for this year’s set of meetings is “structural shifts in the global economy”. This is likely to mean lots of talk about peak interest rates, productivity, the impact of AI on the global economy and, of course, the future path for global inflation. China will likely also feature heavily in the discussions, especially as its economy has diverged from the West, and interest rates and bond yields are falling. The keynote speech is from Jerome Powell on Friday, while we don’t expect him to criticise Chinese authorities for their insipid stimulus that is impacting China’s economic potential, all eyes will be focussed on what he says about the Fed’s next move in interest rates.

 No easy fix for the Chinese economy

Looking at China first, Chinese stock indices may have risen on Tuesday, however, this comes after a slump on Monday, as investors reacted to moves by the PBOC to cut lending rates and stimulate the beleaguered economy. The PBOC cut its 1-year lending rate by 10 basis points, to 3.45%, but kept its 5-year rate steady at 4.2%. This fell short of expectations and analysts had expected a cut to rates of 15 basis points. The Chinese economy is having something of an existential crisis: weak demand and the deflation of an epic property bubble are proving to be hard problems to solve. Although the Chinese authorities have been blamed for not doing enough, including not cutting rates fast enough, it’s wrong to say that Chinese authorities have not done anything to stem their economic problems. They have cut mortgage and lending rates, they have given generous EV subsidies, they have intervened in the forex market and relaxed trading regulations. The next thing to do would be to add some fiscal stimulus to the mix to try and beat deflation once and for all. However, it appears that Beijing has no appetite for such reform.

Why the PBOC won’t take more radical action, for now

Unlike in the West, where fiscal stimulus works too well, hence our post-Covid inflation problem, there is a good argument to be made that fiscal stimulus would not work in China. This is because consumers tend to be savers, especially during periods of economic gloom, such as now. Added to this, there is a concern about national indebtedness, especially as China’s property woes have stemmed from massively leveraged property companies that it is estimated could knock 6% off MSCI China companies’ earnings this year. Thus, as China makes its shift from a property investment led economic model and shrinks its real estate sector to something that is more in line with fundamental demand, there will be some suffering. Thus, the divergence with the West could be ongoing for some time, and nothing anyone says at Jackson Hole or elsewhere, will make a difference. Overall, the divergence between US stocks and Chinese stocks will likely continue, and China’s problems could take many years to fix.

No stopping Nvidia

There was an interesting dynamic in financial markets at the start of the week. The 10-year Treasury yield continued its march higher on Monday, it rose above 4.3%, a rise of approx. 45 basis points in one month. At the same time as yields rose, stocks also moved higher on Monday, led by technology stocks, and the dollar softened. Usually, the opposite happens and when yields rise, the dollar rises with them, and stocks can sell off. So, what is going on? Firstly, it’s worth noting that movements in any asset class in mid-August should always be taken with a pinch of salt. However, there is no denying that Nvidia’s earnings report, which is scheduled for release on Wednesday, is causing excitement in the market. Its Q1 earnings report that was released in April set the market alight, after it beat EPS estimates by more than 18%, and gave an upbeat assessment of earnings. Shares in Nvidia have risen by 220% YTD, and the markets are expecting a similar good news story later this week. Nvidia’s share price rose more than 8% on Monday, after HSBC was the latest investment bank to upgrade its price target for the stock, they now expect Nvidia’s share price to rise to $780, the share price is currently trading around $470, and pre-market trading suggests that the stock will rise by a further 1.5% on Tuesday. The AI technology boom is here to stay, according to HSBC analysts, and Nvidia is at the forefront of this move. Wednesday’s earnings report will need to beat already high expectations if this momentum in the stock price is expected to continue. However, if AI is going to lead the next phase of the industrial revolution, and boost global productivity, then who can argue with the investment case for the video chip maker?

Why the dollar rally has fizzled

The FX market is having something of a lull now that the dollar is not moving with Treasury yields. The jump in 10-year yields to a 16-year high, is not filling the broader financial market with fear as one might expect. NVidia is one of the reasons why since this stock could lead the global economy into another cycle of growth. Added to this, Microsoft is giving its proposed takeover of Activision Blizzard another go and has sent a new proposal for the purchase to UK regulators who blocked the original proposal earlier this year. Added to this, Arm, the UK chip maker, is planning to list on the Nasdaq, which should add some star quality to the IPO market later this year. The rise in 10-year yields in the US may not be causing alarm at the Federal Reserve, who could see it as a sign of economic strength, at the same time as inflation is falling. The US economy is not showing signs of struggle, even with elevated interest rates, thus the slow puncture of the inflation bubble in the US and Europe, is helping to drive sentiment towards risk and keep volatility low. While we don’t expect central bankers to do a victory lap around the rangelands of Wyoming later this week, there could be a sigh of relief that the unified rise in interest rates in the west has not caused more economic damage. It’s worth noting that when all is well in the world of financial markets, the dollar doesn’t need to rally – so that is one argument that supports mild dollar weakness in the near term.