Shocks and Surprises, Week Ending March 11th

There is a difficulty, because the biggest shock of the week was China's February trade data, but the  explanation for US$31.5 bn February trade deficit is quite different from that we're picking up from the way in which exports and imports deviated from consensus.

For the record, China's export growth of 18.4% YoY was far below the consensus forecast of 31.1%, whilst import growth of 39.6% YoY was within the range of consensus expectation (which ran from 20.4% to 42.2%). Judging from that consensus, the explanation for the trade deficit is simple: exports are weak, mainly thanks to a slowdown in European markets.

The problem with that conclusion is that it is wrong. I cannot explain why the consensus forecast for export growth in February was so high: simply adhering to seasonal patterns would have suggested growth of 13.6% YoY. In fact, exports did slightly better than normal seasonal patterns despite problems in the EU. True, exports to the EU rose only 2.2% YoY (vs a fall of 3.3% in January), but exports to the US were up 22.6% YoY (5.4% in January), to HK were up 22.5% (down 16.4%), and to Asean were up 34.1% (5.6%).

Is my reading of February's relative export strength merely a trick of the Chinese New Year calendar? No: February's sequential export growth was 0.33 SDs above seasonalized trends; combined Jan-Feb export were 0.11 SDs above trends, and Dec-Feb exports were 0.04SDs below trends.

The same sort of analysis for China's imports gives a very different result: China's 39.6% YoY jump in February represented a sequential jump of 19% MoM, which was 2.41 SDs above seasonalized trends. For Jan-Feb, the growth of imports was 0.77SDs above trends, and for Dec-Feb imports were 0.31SDs above trend.

In short, exports were resilient, but the import bill was a true blow-out. I have no idea how the majority of the 29 economists forecasting China's February export growth generated their forecasts.

Unfortunately, the obvious but incorrect storyline of the trade balance being undermined by weak exports is easier to square with the rest of the shocks and surprises of China's February's data than the true story of powerful import demand breaking the trade surplus. For February's data also produced negative shocks on:

• industrial production (up 11.4% YtoY during Jan-Feb, vs consensus expectation of 12.5%);
• retail sales (up 14.7% YoY during Jan-Feb, vs a consensus of 17.4%);
• M1 monetary aggregate (up 4.3% YoY in February, vs consensus of 6.1%).

Other data (M2 up 13% YoY and new yuan loans up 710bn yuan in February, urban fixed asset investment up 21.5% YoY during Jan-Feb, CPI up 3.2% YoY and PPI flat) arrive in line with consensus. 

How, then, to explain coherently this spread of surprises and disappointments? I think two contradictory forces are revealed. First, the really sharp slowdown in M1 growth, coupled with a disappointment in retail sales and a suddenly serious trade deficit all tells us that the economy itself right now is not generating positive cashflow. This lack of cashflow (largely a function of the misallocation of investment since late 2008) is finally having an impact on spending patterns and consumer sentiment. Although measured consumer confidence picked up slightly in January from the record lows of late 2011, it remains at historically low levels (in January about 1.3SDs below the long-term series average.)

But the surge in imports tells a completely opposite story – one in which China's trading environment is expected to improve sharply in the near future, and is therefore re-inventorying sharply. Thus February's data disclosed sharply higher import volumes of crude oil, refined products, iron ore and copper. This expectation is backed by the unrecognizedly resilient export growth, and is bankrolled by new yuan lending which, at 1.45tr yuan during Jan-Feb, was fully 50% higher than the same period last year! And that new lending is also, of course, directly showing up in the sustained investment spending, and even in other regional data, such as the 20.1% MoM in export orders recorded in January by Japan's machinery industry.

If this is the balance of forces – negative cashflow generation offset by sustained new lending funding investment spending and reinventorying – then we should expect the latter force to prevail over the short to medium term.

Elsewhere in the world, the shocks and surprises of last week revealed little we didn't already know: in the US, non-farm payrolls surprised positively not only by adding 227k during February, but also because of major upward revisions made to the (already positive) data for January and December. US consumer credit totals also surprised positively for the third month in a row, with non-revolving credit rising US$20.7bn on the month. Economists have not yet figured out what is happening – but essentially it's the Federal Government which is doing all the new lending. Is it too cynical to observe that this is an election year?

Europe continues to produce exclusively negative shocks, with the tally this week including Italian industrial output (down 5% YoY), UK industrial output (down 3.8% YoY), German factory orders (down 4.9% YoY). In addition, we also saw the unexpected deterioration in France's fiscal position during January, as spending was up 24.8% YoY, whilst revenues were up only 14% YoY. Is it too cynical to observe that this is an election year?