China’s An Underachiever

The big news last week was China’s announcement of its latest economic growth target and the lack of an announcement of any new major economic stimulus – both widely viewed as disappointments. The consequences were far reaching considering that the lower-than-expected target has big implications for the global economy, commodity markets, and more. Adding to investors’ bad mood last week was Fed chair Jerome Powell spooking markets by warning that the US central bank might have to revert back to bigger interest rate hikes. What’s more, Powell said that the Fed will most likely have to increase interest rates to a higher peak than previously thought. That led to big moves in the bond market and left the yield curve in its steepest inversion in 42 years – a strong signal of a looming recession. Finally, Silvergate Capital announced plans to wind down its operations after the digital assets industry’s latest meltdown sapped the bank’s financial strength. But it wasn’t the only bank in trouble last week, with Silicon Valley Bank also collapsing in what will go down as the second-biggest US bank failure in history. Find out more in this week’s review.

Macro

Last week, China’s government officially set an economic growth target of “around 5%” for 2023 and avoided any mention of large economic stimulus for the year. The objective was the lowest in over three decades and down from last year’s goal of 5.5%. Economists were expecting (and investors were hoping for) a goal of above 5%. But many reckon that the Chinese government purposely set a conservative target that would be easier for the president’s new economic team to meet, after falling far short of its goal in 2022. The world’s second-biggest economy expanded by just 3% last year – 2.5 percentage points below target – on the back of the government’s zero-Covid policies, which hit growth. On the flip side, the low base from last year will make this year’s growth target easier to achieve.

China’s official economic growth targets have been trending lower over the past decade as the government looks to rein in the country’s growing debt pile. There’s probably a desire among policymakers to avoid overstimulating the economy and accumulating too much more debt – concerns that linger after an overdone response to the 2007-08 financial crisis. What’s more, in announcing 2023's target, China’s prime minister said that the aim this year was to prioritize economic stability and boost domestic demand (a reference to consumer spending and business investment). The government, after all, is trying to rely on consumers to drive the economy and is reluctant to juice growth through commodity-intensive sectors like real estate and infrastructure.

China’s growth matters for the global economy. The International Monetary Fund, for example, estimates that when China’s GDP growth rate rises by 1 percentage point, the pace in other countries increases by around 0.3 percentage points. That could spell good news for the global economy considering that China’s 2023 growth target is 2 percentage points higher than the 3% expansion the country recorded last year. On the flip side, the uptick in growth could fuel global inflation at a time when central banks all over the world are racing to bring it back under control. Bloomberg Economics, for example, forecasts an acceleration in China’s economic growth rate from 3% in 2022 to 5.8% in 2023. That could lift global inflation by close to a full percentage point in the final quarter of 2023, according to Bloomberg, which modeled the relations between China’s growth, energy prices, and global inflation.

Over in the US, Fed chair Jerome Powell spooked markets last Tuesday after warning that the US central bank is prepared to return to bigger interest rate hikes if needed. The comments, made to Congress on Tuesday, raised the possibility of the Fed lifting interest rates by 50 basis points at its next meeting if upcoming reports on jobs and inflation show that rate hikes have done little to cool the economy. What’s more, Powell said that the Fed will most likely have to increase interest rates to a higher peak than previously thought after the latest economic data came in stronger than expected.

The comments led to a selloff in stocks and short-term government bonds, while the dollar rose. Traders also increased their bets on a half-percentage-point rate hike at the Fed’s March 21-22 meeting, with the odds now favoring such a rise rather than a quarter-point increase. What’s more, traders now see rates peaking at close to 5.6% this year – up dramatically from below 5% just a few months ago.

Linked to those more aggressive interest rate bets, the yield on two-year Treasury notes touched 5.04% on Wednesday – its highest level since 2007. Critically, longer-dated yields didn’t move much, with the 10-year rate remaining under 4%. As a result, the closely-watched spread between 2- and 10-year yields showed a discount larger than a percentage point for the first time since 1981. Put differently, the moves left the yield curve in its steepest inversion in 42 years. An inverted yield curve, in which yields on short-dated bonds are higher than those of longer-dated bonds, is often viewed as a harbinger of recession, with inversions typically preceding economic downturns by 12 to 18 months.

Stocks

Silicon Valley Bank (SVB) was shut by US regulators last Friday after customers raced to withdraw $42 billion (a quarter of its total deposits) in one day and the bank failed to raise new capital. The collapse, the second-biggest US bank failure in history, shook markets, spooked investors in financial stocks, and led to contagion in the startup world considering that SVB had positioned itself as the go-to bank for founders and VC firms. It all started with those very startups and VCs rushing to yank out their cash last week after rumors started swirling about SVB’s financial position, with the bank facing significant losses on its bond portfolio due to higher interest rates. The bank first tried to raise $2.25 billion in new funding but failed. It then looked for a buyer to save it, and that failed too. By Friday, it was all over. Amid the chaos, SVB’s stock price plunged by 63% last week before trading in its shares was halted on Friday morning.

Commodities

The commodity market was also impacted by China’s lower-than-expected economic growth target and the government’s decision to not announce any major new stimulus. See, as the world’s biggest consumer of raw materials, China is an important driver of commodity prices. So after the country’s disappointing announcement last week, commodity markets headed lower, led by iron ore and copper. The absence of a landmark announcement to boost real estate and infrastructure was particularly worrying among metals investors, many of whom were looking for more stimulus to support this year’s rally. Incidentally, that rally was mainly fueled by bets that China’s post-Covid economic reopening would boost demand for metals.

Crypto

As the saying goes, “another one bites the dust”. That is, we have to write about yet another crypto-related bankruptcy. Silvergate Capital, the regional lender that transformed itself into the go-to bank for crypto firms, plans to wind down its operations after the crypto industry’s latest meltdown sapped the company’s financial strength. In the past few years, Silvergate emerged as the biggest crypto bank in the US, attracting as much as $14 billion in customer deposits and reaching a stock price of more than $200 in late 2021. But its fortunes have tumbled since the collapse of crypto exchange FTX. In a statement last week, the firm said that “In light of recent industry and regulatory developments, Silvergate believes that an orderly wind down of bank operations and a voluntary liquidation of the bank is the best path forward.”. The disclosure sent its stock down more than 30% in after-hours trading on Wednesday to below $3 a share.

This week

• Monday: Nothing major.
• Tuesday: UK labor market report (February), US inflation (February).
• Wednesday: Chinese retail sales and industrial production (February), US retail sales (February). Earnings: Adobe.
• Thursday: Japanese trade balance (February), ECB interest rate decision, US housing starts (February). Earnings: FedEx.
• Friday: US industrial production (February). Earnings: Xpeng.