Chinese indicators are showing signs of stabilising amid the latest bout of fiscal stimulus, and our out-of-consensus call foreseeing positive Chinese growth surprises, has begun playing out. Developments in the US-China trade negotiations will be key.

At the annual National People's Congress meeting in mid-March, Chinese policymakers said they will provide strong fiscal stimulus in 2019.  The stimulus includes a VAT cut worth approximately $90bln, and a significant boost in infrastructure spending through an increased quota for special bond issuance.  Such measures should equate to roughly a two percentage point rise in China's so-called "augmented fiscal deficit" this year, and the expansion is beginning to appear in fiscal indicators.

Monetary policy easing is probably ending, although we expect the reserve requirement ratio to be reduced further this year. Real estate policies may be loosened in some cities but probably not nationwide, given high leverage in the sector.

Relative to the past, the government stimulus initiated late last year looks managed compared to the response to previous downturns in 2015, and certainly compared to 2009. How effectively such stimulus will support the real economy remains to be seen, particularly with respect to private companies that still face tight credit conditions, according to various media reports.

Notably, the goal of stimulus is also more modest this time, aiming for 6-plus percent real GDP growth in 2019 compared to 8% growth in 2009 and 7% growth in 2015. And policymakers do not face the equity/FX volatility and capital outflows that were present in 2015, as capital controls seem to be holding up well. In addition, progress on the US-China trade war has also helped soothe sentiment, which had been a major drag on manufacturing for much of 2018.

As this fiscal-led stimulus percolates, both hard and survey data flow is starting to show signs of a rebound in China. For instance, the latest business survey release showed a strong uptick that surpassed the typical rises that accompany the timing of the New Year.  Beyond business surveys, indicators are stronger in China than other exporters – this is linked, we believe, to the meaningful stimulus put in the pipeline in Q4 2018.

Trade talks: timing, longer-term issues

Turning to the US-China trade dispute, news flow has stabilised and there are indications that a deal could prevail in coming months, if not weeks.

We continue to believe that the best timing for resolution from the US side is late summer, in order to maximise the impact on the US presidential election year in 2020. Meanwhile for China, removing tariffs appears to be an important objective that will also take time to generate.

Despite the significant de-escalation of risks, some of the more profound issues brought to the surface by trade-induced tensions are likely to remain unresolved, in our view. We see two key sticking points going forward: firstly, emerging signs of Chinese dominance in artificial intelligence over the US, especially with regard to security; secondly, discord on intellectual property rights. We expect a deal focusing mostly on the trade dimension of the conflict, but see the high likelihood of further confrontation after the US presidential elections next year.   

Chinese risk asset markets have rightly priced out some of the more extreme, negative scenarios. We now see tangible signs of Chinese data steadying and this will be key to prolonging the rally in the coming months of the year.

Continued stabilisation of China’s economic growth will be crucial for EM assets more generally, too, as will the dovish central bank backdrop. However, an upswing in idiosyncratic risks in a few central countries, such as Turkey and Brazil, could create wobbles in the broader EM complex as well.

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