China – CC&L Financial Group Ltd.

Monetary trends suggest that China’s economy is better placed to withstand tariff damage than Japan’s.

Chinese six-month real narrow money momentum rose further in March, reaching its highest level since August 2020. Japanese momentum moved deeper into contraction – see chart 1. (US March numbers will be released next week, with Eurozone / UK data the following week.)

Chart 1

Inflation divergence has contributed to the wide gap but it mainly reflects nominal money trends: Japanese narrow money is contracting even in nominal terms.

The Japanese fall is partly explained by money-holders switching out of sight deposits (included in narrow money) into time deposits (excluded), which now pay modest interest. Still, broad money trends are also weak: M3 grew by just 0.5% at an annualised rate in the six months to March. Broad money expansion has been dragged down by BoJ QT and a fall in bank lending to non-bank financial corporations.

By contrast, six-month growth of Chinese broad money – on the preferred definition here excluding deposits held by financial institutions – was stable in March at a level close to the 2015-19 average. This pace was associated with solid nominal GDP expansion – chart 2.

Chart 2

Broad money trends have been supported by PBoC and state bank purchases of government bonds issued to finance fiscal stimulus measures. In addition, six-month growth of bank lending has revived recently, despite a drag from debt swap operations (under which funds raised through bond issuance are used to repay bank loans of government-related entities).

Previous posts suggested that Japanese monetary weakness would be reflected in downside economic and inflation surprises. The composite PMI output index fell sharply last month, to well below levels in the US, Eurozone, UK and China.

Annual growth of scheduled earnings, meanwhile, undershot expectations in February. Inflation believers have been relying on a developing wage-price spiral but bumper headline pay awards in the spring Shunto may not be representative of trends across the whole economy – chart 3.

Chart 3

MSCI indices for continental Europe and China have outperformed year-to-date – see chart 1.

Chart 1

The pattern of returns echoes monetary trends: six-month real narrow money growth has picked up in China and continental Europe while moving sideways in the US, with Japan and the UK lagging – chart 2.

Chart 2

A previous post noted that Chinese money / credit numbers strengthened significantly in December. The pick-up was sustained in January: six-month growth rates of the narrow / broad monetary aggregates followed here rose further and are back around the middle of recent historical ranges – chart 3.

Chart 3

The official M1 definition has been revised to include personal demand deposits, aligning it with international practice. The new measure is close to the “true M1” aggregate used here historically.

Annual growth of official M2 eased from 7.3% in December to 7.0% in January. The slowdown, however, reflected a fall in bank deposits held by non-bank financial institutions – movements in such deposits are less informative about economic prospects. Annual and six-month growth of non-financial M2 rose further in January.

The sharp turnaround in six-month narrow money momentum has been mirrored by a “credit impulse” measure based on the six-month flow of total social financing – chart 4.

Chart 4

The turnaround in money / credit momentum partly reflects the negative impact of regulatory changes last spring dropping out of six-month calculations. Seasonal adjustment is more uncertain in January / February because of New Year timing effects. Money / credit growth is not yet strong by historical standards.

Still, money trends warrant increased confidence that domestic demand growth will recover sufficiently to offset any loss of support from net exports due to trade conflict.

MSCI China remains on a steep valuation discount to the rest of EM despite recent outperformance – chart 5. Chinese six-month real narrow money momentum is now stronger than in most other EMs – chart 6.

Chart 5

Chart 6

Chinese money and credit numbers for December suggest that policy stimulus is becoming effective, warranting an upgraded assessment of economic prospects.

Six-month rates of change of broad / narrow money and broad credit (total social financing) bottomed in June / July but the recovery through November was modest. All three jumped higher in December – see chart 1.

Chart 1

Money measures – particularly narrow money – were negatively distorted last spring by regulatory enforcement of deposit rate ceilings*. The revival in six-month momentum partly reflects the dropping out of this effect. Still, December readings should be undistorted and broad money momentum is close to its 2015-19 average, when nominal GDP grew solidly.

Monetary financing of fiscal easing has been a key driver of the money growth pick-up. Banking system net lending to government (including by the PBoC) contributed 2.0 pp (not annualised) to M2 growth in the six months to December, the most since the 2015-16 stimulus episode.

An apparent weak spot in the December release was a further fall in annual bank loan growth (i.e. excluding lending to government). The numbers, however, are being distorted by debt swap operations, involving repayment of bank loans by government-related organisations. Six-month loan momentum has edged up despite this drag, with household lending weakness abating – chart 2.

Chart 2

Will the money growth recovery continue? Recent renewed pressure on the currency has been associated with a resumption of f/x sales and a firming of money market rates. The increase in term rates has so far been modest and may be offset by ongoing support from money-financed fiscal easing.

*Lower interest rates on demand deposits resulted in enterprises moving money into time deposits and non-monetary instruments while repaying bank loans.

Chinese money trends are normalising after weakness, suggesting modest economic improvement.

A previous post argued that a recovery in money growth was under way but the extent of reacceleration was uncertain. A revival remains on track but has so far proved lacklustre.

Money numbers were distorted in the spring by regulatory enforcement of deposit rate ceilings, which led to corporations switching out of demand deposits into time deposits and non-monetary instruments. Broader money measures were less affected, resulting in a focus here on the “M2ex” aggregate (i.e. official M2 minus deposits of financial institutions, which are volatile and less correlated with future activity / prices).

Six-month M2ex momentum bottomed in June and recovered further in November, though remains below its 2015-19 average – see chart 1.

Chart 1

Narrow money momentum is much weaker but has started to normalise as the spring distortion drops out of the six-month comparison. (The “true M1” measure shown approximates to a new official M1 definition to be adopted from January.)

Chinese money momentum has led nominal GDP momentum by two quarters on average historically, so monetary reacceleration since mid-year suggests better economic data from early 2025.

November activity numbers were positive on balance. Six-month rates of change of industrial output, fixed asset investment and home sales rose further but retail sales disappointed – chart 2. Output strength could reflect front-loading ahead of tariffs.

Chart 2

The suggestion from monetary trends of improving prospects is supported by the OECD’s composite leading indicator, six-month momentum of which has turned positive, suggesting above-trend growth – chart 3.

Chart 3

Real money momentum has led leading indicator momentum by four months on average historically but the low in the latter occurred earlier on this occasion, perhaps reflecting the regulatory distortion to monetary data mentioned above.

A post last month suggested that Chinese money growth was bottoming, based on year-to-date policy easing and the space for additional stimulus opened up by a stabilisation of the currency. September money numbers and recent policy announcements bolster this assessment but the scale of monetary acceleration is uncertain.

As previously discussed, narrow money measures have been distorted by regulatory changes in April that reduced the attractiveness of demand deposits, arguing for giving greater weight to broader aggregates. Six-month growth of the preferred broad measure here – M2 excluding deposits of non-bank financial institutions – bottomed in June, edging up further in September. Broad money has led nominal GDP by around six months at momentum turning points historically, suggesting that two-quarter nominal GDP expansion will bottom by year-end – see chart 1.

Chart 1

Narrative about the insufficiency of the latest initiatives may underestimate policy stimulus already in the pipeline. Government net securities issuance reached CNY10.8 trillion or 8.3% of GDP in the 12 months to September, the highest proportion since 2017 and up by 2.6 pp from the prior 12 months. A further increase is likely. The banking system buys the bulk of securities so increased issuance usually boosts broad money growth (unless funds are used to repay other bank lending or increase system capital) – chart 2*.

Chart 2

Stimulus packages in 2008-09 and 2015-16 succeeded in reflating nominal GDP growth; smaller-scale initiatives in 2012-13 and 2019-20 resulted in stabilisation but little increase – chart 3. The extent of a recovery in money growth will signal which scenario is more likely. Markets appear to be discounting the latter: the yield curve (10s-2s) has steepened but less than in 2009 and 2015, while the rally in MSCI China still leaves it on a significant forward P / E discount to the rest of EM – chart 4.

Chart 3

Chart 4

*Increased issuance is reflected initially in a rise in fiscal deposits, excluded from monetary aggregates. The monetary impact occurs when funds are deployed. A rise in fiscal deposits reduced the contribution of banking system net lending to government to annual M2 growth by 0.3 pp in September.

Chinese money / credit trends remain weak but could be at a turning point.

Six-month rates of change of broad money and total social financing have stabilised above June lows – see chart 1. (Broad money here refers to M2 excluding money holdings of financial institutions, which are volatile and less informative about economic prospects.)

Chart 1

Narrow money is contracting at a record pace but has been distorted by regulatory changes in April that have reduced the attractiveness of demand deposits, resulting in enterprises shifting into time deposits and money substitutes while repaying some short-term bank borrowing. (The “true M1” measure shown adds household demand deposits to the published M1 aggregate to align with international monetary convention.)

Chart 2 compares six-month rates of change of the raw narrow money series and two adjusted measures. The first assumes that the share of demand deposits in total bank deposits of non-financial enterprises would have remained at its March level in the absence of the regulatory changes. The second additionally adds the inflow to instant-access wealth management products (WMPs) since end-March (data sourced from CICC), on the assumption that this represents a transfer from demand deposits. Six-month momentum of the latter measure was similar in July to the series low reached at end-2014.

Chart 2

A key reason for expecting money / credit reacceleration is that the yen rally has relieved pressure on the RMB, easing monetary conditions directly and opening up space for further PBoC policy action. The balance of payments turnaround is confirmed by a swing in the banking system’s net f/x transactions, including forwards, from sales of $58 billion in July to purchases of $10 billion in August. This series captures covert intervention via state banks (h/t Brad Setser) and an August reversal had been suggested by a sharp narrowing of the forward discount on the offshore RMB, which has remained lower so far in September – chart 3.

Chart 3

Actual and expected monetary easing has been reflected in a further steepening of the yield curve, which has correlated with, and sometimes led, money momentum historically – chart 4.

Chart 4

An easing of Chinese monetary conditions coupled with the start of a Fed rate-cutting cycle could have a powerful monetary impact in Hong Kong, where six-month momentum of local-currency M1 recently returned to positive territory, having reached its weakest level since the Asian crisis in October 2022 – chart 5.

Chart 5

The most important issue in the global economic outlook is the meaning of Chinese monetary weakness.

Six-month rates of change of narrow / broad money, bank lending and total social financing (on both new and old definitions*) reached record lows in June / July – see chart 1.

Chart 1

Monetary weakness has been entirely focused on the corporate sector: M2 deposits of non-financial enterprises plunged 6.6% (13.6% annualised) in the six months to July (own seasonal adjustment) – chart 2.

Chart 2

Recent regulatory changes appear to account for only a small portion of the corporate broad money decline.

A clampdown on banks paying interest above regulatory ceilings has resulted in a shift out of demand deposits but money has largely stayed in the banking system – available data suggest modest inflows to wealth management products and other non-monetary assets.

The clampdown has also discouraged the practice of “fund idling” (round-tripping in UK monetary parlance), whereby banks offered loans to corporate borrowers to meet official lending targets, with borrowers incentivised to hold the funds on deposit.

If an unwinding of such activity accounted for the decline in corporate money, however, short-term bank lending to corporations would be expected to show equivalent weakness. Such lending has continued to grow, albeit at a slower pace recently, as have longer-term loans.

A trend decline in the ratio of corporate M2 deposits to bank borrowing, therefore, has accelerated – chart 3.

Chart 3

Household money holdings, by contrast, have been growing solidly – chart 2. An alternative explanation for the corporate money decline is simply that households are still hunkering down as the property crisis deepens, with weakening demand for consumer goods / services and housing transferring income and liquidity from the corporate sector.

The latest PBoC and NBS consumer surveys confirm rock-bottom sentiment – chart 4. If this explanation is correct, corporate money weakness may presage a collapse in profits – chart 5.

Chart 4

Chart 5

Why hasn’t the PBoC hit the panic button? Policy easing has been constrained by currency weakness: the most comprehensive measure of f/x intervention (h/t Brad Setser) reached $58 billion in July, the highest since 2016 – chart 6. The recent yen rally has offered some relief, reflected in a narrower offshore forward discount, but the authorities may be concerned that this will prove temporary.

Chart 6

The strange policy of trying to push longer-term yields higher against a recessionary / deflationary backdrop may represent an attempt to support the currency, rather than being motivated primarily by concern about financial risks. To the extent that the policy results in banks selling bonds, however, the result will be to exacerbate monetary weakness and economic woes.

*The previous definition excludes government bonds so is a measure of credit expansion to the “real economy”.