Iron ore and copper prices have fallen sharply over the last week, with most of the focus on the apparent halt of financing demand. While the role of financing is clearly important, it is not the entire story, with slower growth in consumption of these commodities becoming clearer as financing demand has evaporated.
It also appears that the stance of monetary policy has been changed in light of weaker activity and strains in credit markets, with SHIBOR rates collapsing. This could be important in turning these markets around, although its too early to make that call given lags.
Most of the headline data for Jan-Feb was relatively weak. Industrial production slowed to under 9%YoY for the first time in a long time, while power generation was also quite a bit weaker at 5.5%YoY. Crude steel production growth was 1.7%YoY, which was slower than the CISA data implied, although the levels are higher given problems with estimating small mills.
Property market activity also looks to be slowing. Residential property sales have been falling YoY for the past couple of months, while commercial property has also started the year on a soggy note. This hasn't affected the construction pipeline yet, but ultimately will coming into 2H14.
Credit dynamics look to be restrained. The increase in total social finance in February was less than the same month in 2013, although January was quite a bit bigger than expected. Loans via trust products in particular were the weakest in February for sometime. This suggests higher interest rates and default risks are starting to take its toll on shadow banking.
Looking at some of the higher frequency data, steel production and coal burn were steady but unspectacular at the end of February. Crude steel output recovered from the sharp drop in the previous 10 days, although growth remains slow.
As outlined in the
review for iron ore posted here, steel consumption doesn't have to grow much for prices to remain at decent levels. And it does appear that the most recent sharp drop in iron ore is partially due to destocking of ore and uncertainty about steel inventories, which are starting to look a bit less troubling. So in the very short term, the statistics don't suggest that prices will continue to fall sharply.
Coal burn was up ~4%YoY in the last 8 days of February and inventories at key power plants are now down to 20 days of use. This is probably still too high, with Chinese domestic coal prices continuing to slip. There is not a particularly good reason to think this will change in the very near term, with movements in hydro generation the next key variable to get a grip on.
One of the more interesting developments that hasn't attracted much airtime is the big drop in SHIBOR rates. To be sure, there is lots of reporting of spikes, but not a lot of interest in sharp falls.
Overnight SHIBOR rates are now back to where they were before they rocketed higher in mid-2013 at ~2%.
Through February it could be argued that this was because of tensions in markets kept 1 week rates high. But spreads here have now collapsed, with 1 week interbank rates currently lower than early 2013.
What hasn't changed is 3 month rates, which remain stubbornly high, with spreads to overnight rates widening. This is likely to be in part a liquidity issue, given the vast majority of interbank lending occurs on an overnight or 1 week basis.
The big question is whether this, along with the ongoing weakness in the RMB, represent a significant change in tack from the PBC? This would be a big move from the tightening stance seen a few months ago. Changes in central bank policy are also usually a key turning point for markets.
Even if the PBC has moved lower interest rates, it is probably too early to become bullish on the cycle. Firstly, we don't know the extent of the damage from the high interest rates seen a few months ago. Secondly, its not clear whether the drop in interest rates will turn momentum round, especially given policymakers still seem intent on starving credit to some parts on the economy.
So its worth staying cautious for now, but the hint of policy change is necessary for data to surprise to the upside sometime in the future.
