State Street Global Advisors’ head investment strategist has sounded a warning about the implications of a deteriorating Sino-US relationship, following tense exchanges during President Xi Jinping’s visit to America last month.
China’s behaviour as a global player in the coming year will determine much of what happens around the world, but there are fears that Beijing will place domestic considerations above all else, said George Hoguet, Boston-based global investment strategist at SSGA.
However, the Chinese government recognises this and will therefore be reluctant to let its currency weaken, he told AsianInvestor while in Hong Kong last week.
Still, China’s relationship with the US is likely to come under considerable pressure and will require “skilful management”.
“I am quite optimistic for the medium-term prospects and our [the US’s] ability to manage the China relationship,” Hoguet said. “But it is a fact that, under Xi, China has become more assertive, more inward-looking and more repressive. These are things investors have to think about.”
With the US and China accounting for 40% of global economic growth, skilful management of the Sino-US relationship will be vital in 2016, he added. “In an election year [for the US], the management of our relationship with China will become an increasingly important issue.”
Tensions remain high, with the US skeptical of Beijing's sincerity, particularly in areas such as intellectual property and cyber-security. For example, the US alleges that servers in the US Office of Personnel Management, which contain the personal files of all federal employees, were hacked, and their chief suspect is China.
While many constructive discussions took place during the 40 working groups set up for Xi’s visit, said Hoguet, the US would consider sanctions if there were no acknowledgement by China of American concerns over IP and internet security. This would naturally lead to a deterioration of Sino-US relationship.
Hoguet acknowledged this is not a one-sided issue, but said “we can’t tolerate an asymmetric relationship”.
When it comes to wider global economic issues, Hoguet argues that the main risk is the world remains stuck in a low-growth, low-inflation environment, and on the cusp of deflation exacerbated by the sharp downturn in China.
Beijing has the tools to manage the economy but momentum is slowing, he observed.
“China continues to benefit from substantial fiscal and monetary policy flexibility. Real interest rates continue to be quite high. The GDP deflator [a measure of prices of all new, domestically produced goods and services in an economy], is close to zero, but the prime lending rate is 6.9% [as of early October]. Consensus expection is for at least two more interest rate cuts in the next 12 months and further reductions in the required reserve ratio.”
But this summer’s mainland stock market crash, and policymakers’ subsequent intervention to support prices, have engendered major uncertainties, said Hoguet. That said, he sees a financial crisis as unlikely in the coming year.
By financial crisis, he meant a downturn in the real economy sparking an acceleration in capital outflows. That would lead to the renminbi – which is 8-9% overvalued, by SSGA’s reckoning – losing government support and weakening by 15%, leading to debt-servicing problems for many Chinese companies that have borrowed in dollars, noted Hoguet.
It would also spark defaults of wealth management products, due to malfeasance, fraud or just reduced cashflows, he added. “The authorities will say they will make an example of these firms, and then you have investor panic.”