Global Macro: Expectations Decline for U.S. Rates, China Growth

Traders see Chinese GDP dipping below 7 percent, U.S. rates staying lower for longer and risks growing in Europe and Japan.


Divergence isn’t just an emerging-markets phenomenon. The world’s major economies have taken sharply different trajectories of late, with China trending lower, Europe flirting with recession and deflation and Japan sputtering even as the U.S. keeps powering ahead.

Global macro traders had a decidedly mixed record of forecasting developments in these economies last year. Will they fare any better in 2015?

Let’s start with China, which generates the most consistent macroeconomic numbers of any major economy — and the greatest amount of skepticism over whether those numbers reflect reality. The London- and New York–based global macro traders that I survey every six months were correct last year in foreseeing a measured reduction of China’s real gross domestic product growth rate, but they got the magnitude wrong.

In June 2014 these traders assigned a 56 percent probability to China’s growth rate falling below 7 percent in 2014. That was slightly more pessimistic than their forecast in December 2013, reflecting skepticism about the quality of official statistics and even deeper fears of the risks of an emerging credit bubble in the People’s Republic.

The majority of the survey takers believed that the government of President Xi Jinping had consolidated power sufficiently to stick with a rebalancing macro strategy in 2014 and avoid the temptation to resort to fiscal or monetary stimulus to goose growth back up to the government’s 7.5 percent target. In the event, the survey takers were right about the no-stimulus policy but wrong on the growth number. Growth came in at 7.4 percent for 2014, even as evidence of slower economic activity toward the end of the year suggested that the downward arc of structural adjustment was continuing.


The tone of the National Bureau of Statistics of China’s official press release on January 20 was a marvelous combination of sound macroeconomics and Communist Party rhetoric: “In 2014, faced with the complicated and volatile international environment and the heavy tasks to maintain the domestic development, reform and stability, the Central Party Committee and the State Council have adhered to the general tone of moving forward while maintaining stability. As a result, the national economy has been running steadily under the new normal.”

“China’s GDP is a political number, not a truly economic number, so it is no surprise that growth came in just perfectly enough to beat expectations both on-quarter and on-year,” says Leland Miller, president of the China Beige Book International, which gathers independent data sources on the Chinese economy. “What’s more surprising is that the lesson investors seem to be taking from the GDP announcement is the correct one, namely, that China is in better shape than analysts have been giving it credit for. Despite the long-term slowdown, our data are clear that certain aspects of the economy remain resilient, most notably job growth and firm profit performance, both of which have improved steadily over the past two quarters. This is the principal reason why stimulus is simply not needed right now. The other reason is that it wouldn’t work anyway.”

Looking ahead, the traders polled in December 2014 see a mean 64 percent probability that China’s GDP growth will fall below 7 percent in 2015.

“The combination of slowing investment activities, the self-correction of the real estate sector and rising local government debt will continue to drag down China’s growth in 2015,” predicts Wolfango Piccoli, managing director of research at Teneo Intelligence. The People’s Bank of China cut banks’ reserve requirement ratio by 50 basis points, to 19.5 percent, on February 4, but Piccoli sees the move as an attempt to avert a liquidity shortage over the Chinese New Year holiday and not a new monetary stimulus effort. The PBOC “aims to prevent systematic risks, while the government continues to prioritize economic reform this year,” he says.

The biggest risk, according to a sample of our traders, is a sudden credit meltdown, triggered by a big default in the mining or real estate sector that rapidly propagates through the state-controlled banking sector. Mainland property companies have borrowed in excess of $65 billion from foreign capital markets (including Hong Kong) over the past three years to sidestep the state-controlled banking sector.

Shenzhen-based real estate developer Kaisa Group Holdings alone issued $2.5 billion of offshore debt. The company missed payments on its offshore debt in January as Kwok Ying Shing, the firm’s founder, was caught (or targeted) by a corruption investigation. “No one believes the recent financial figures, and nobody knows exactly what Kwok Ying Shing did to piss off Beijing,” a Hong Kong–based distressed-debt investor told me. “But Kaisa had some cozy deals with the family of former security chief Zhou Yongkang, now under house arrest.”

On February 4 rival developer Sunac China Holdings announced that it had agreed to buy 49.3 percent of Kaisa from the Kwok family. The deal, if completed, would appear to avert the risk of a default by Kaisa. The company’s plight is far from unique, though. “There are more of these in the pipeline,” the Hong Kong investor told me. “Just wait.”

Indeed, on January 11, Ma Jian was detained over allegations of corruption. He was in charge of counterintelligence at China’s Ministry of State Security, roughly the CIA’s counterpart agency, and was involved in alleged “serious violations of party discipline” — the stock phrase in Chinese Communist Party announcements of corruption charges — in transactions with the Founder Group, a technology conglomerate, and Beijing Zenith, a (guess what) property developer.

“The Bank for International Settlements warned that overseas banks’ lending to Chinese companies has doubled in the past two years, reaching $1.1 trillion,” says Teneo’s Piccoli. “Half of the overseas borrowing originated from real estate firms. The risk associated with private businesses, in particular businesses operating in sectors such as real estate, in which rent-seeking by government officials is endemic, is expected to increase this year. Given Xi’s hard stance on corruption, the government may give priority to political matters over economics.”

Xi’s campaign may also fan China’s accelerating capital outflows, says Piccoli. “The State Administration of Foreign Exchange reported the largest capital-account deficit in over a decade on February 3,” he notes. “China’s overseas direct investment is on the rise, and the economy is in transition. More importantly, the government’s ongoing anticorruption campaign may drive up the capital outflow, as targeted individuals might try to move their money outside the country.”

Also from this series:

In the euro area, politics has trumped — or at least dictated — economics ever since the bloc’s debt crisis erupted five years ago. Is the crisis finally lifting or about to enter a more acute phase?

Our macro traders began turning more positive last year. In the June survey, they put the probability of a default by any euro zone state at just 1 in 10, down from 13 percent in December 2013. For the most part, the market endorsed that view as yield spreads on peripheral sovereign bonds tumbled late in the year, driven largely by anticipation of quantitative easing by the European Central Bank.

In the December survey, the traders’ average prediction was an 83 percent bet that the ECB would embark on QE in the first half of 2015. That forecast proved spot on when President Mario Draghi announced that the central bank would begin buying bonds. The scale was a positive surprise: €60 billion a month for 18 months, or a cool €1.1 trillion.

The big question mark, of course, is Greece. In December the macro traders estimated the risk of a euro exit in the first half of 2015 at 23 percent, roughly twice as high as the perceived risk just six months earlier. At the time, the left-wing Syriza party was dominating the country’s election campaign by promising to end austerity and renegotiate the terms of its massive bailout with the European Union, the ECB and the International Monetary Fund. Syriza’s resounding victory in the January 25 election and initially uncompromising rhetoric by the new prime minister, Alexis Tsipras, sent prices of Greek assets tumbling. In recent days Tsipras and his Finance minister, Yanis Varoufakis, toured European capitals and hinted at a willingness to cut a deal with the troika, but the two sides remain far apart on the terms.

The shift in tone after the new team took power didn’t surprise Teneo’s Piccoli. “With both Varoufakis and Tsipras recently moving away from the idea of an outright haircut on their country’s sovereign debt, policymakers in Berlin feel emboldened to hold the line on key German demands,” he says. “After the hefty rhetoric during the new Greek government’s first week in office, many in Berlin see the recent softening as first evidence that Syriza will have to make concessions to hold Greece within the currency bloc. Against this backdrop, the German government is bracing itself for a prolonged standoff with Athens, especially as many in Berlin believe that time is on their side.”

The potential for Europe to cause wider ripples was underscored in January when the Swiss National Bank abandoned its three-year-old exchange rate ceiling of 1.2 francs to the euro, sending the franc soaring and Swiss equities plunging. The risk wasn’t even on the radar screen when the traders were surveyed in December. Many were caught off guard, including Miami-based hedge fund manager Everest Capital, which saw its main fund — the $830 million Everest Capital Global — vaporized overnight.

The U.S. has become just about everyone’s favorite safe harbor, thanks to the strength of the economy, but that doesn’t necessarily make forecasting any easier. In June the macro traders assigned a 28 percent probability that the yield on the ten-year U.S. Treasury would “normalize” above 3 percent by the end of 2014, and 80 percent that it would be above 2.5 percent. Rarely has the consensus been so far off the mark. The ten-year yield peaked at 3 percent at end of 2013, then dropped in fits and starts throughout the year to finish at 2.17 percent at the end of December. The traders did better on stocks and volatility, assigning a 58 percent bet to the Standard & Poor’s 500 index ending the year between 1,800 and 2,100 (actual close: 2,058.90) and a 55 percent bet that the CBOE’s Volatility index would end the year between 14 and 20 (the VIX closed at 15.91).

The traders’ belief in U.S. rate normalization has taken a big hit. In the December survey, they assigned a 37 percent probability to the U.S. ten-year Treasury yield exceeding 2.5 percent by the end of June. Even that toned-down forecast is looking aggressive now that falling consumer prices have led many analysts to push back the expected timing of the first Fed rate hike. The ten-year yield dropped below 1.70 percent at the end of January.

One of the hard lessons from 2014 is, “Never bet against the Fed,” as a Manhattan-based fixed-income trader told me ruefully. “Ben Bernanke always had more dollars than I do, and so does Professor Yellen.”

John Greenwood, London-based chief economist at buy-side firm Invesco, believes the Fed can afford to take its time in raising rates. “This adds up to a recovery that is now self-sustaining, even without Fed asset purchases, although it is unlikely to become exuberant any time soon,” he says. “If, over the next two years, money and credit growth accelerate, it is likely that the economy will adjust to rate normalization smoothly. Even so, it is unavoidable that market expectations of impending rate hikes are likely to intensify whenever strong economic data points are reported, potentially leading to more volatile financial market conditions in the months ahead. Nevertheless, with the economy now on a steady-paced recovery, it seems unlikely that the Fed or other policymakers will need to act precipitately.”

The traders see a one-third chance that the S&P 500 will close above 2,150 by the end of June, and a 55 percent probability that the VIX will be above 15 by midyear. Tellingly, predictions for volatility are, well, volatile. The mean minimum-maximum range foreseen for the next six months is 12 to 26, wider than the 10-to-22 range that the traders had predicted for the second half of 2014.

Japan was the big disappointment among major economies last year. In June the traders put a 43 percent probability on Japan’s GDP growing by 2 to 2.5 percent for 2014, slightly more optimistic than they had been in December 2013. That call was made in the wake of the country’s blowout first quarter, which saw GDP surge at a 6.7 percent rate. The traders clearly underestimated the squeeze on growth caused by the government’s big consumption tax increase in April, and they overestimated the positive effects of Abenomics’ so-called third arrow of structural reforms. When the fourth-quarter numbers come in, Japan’s GDP is expected to be virtually unchanged from a year earlier.

Such an outcome will come as little surprise to Invesco’s Greenwood. I first met John in his carrel at the Economics Faculty of the University of Tokyo in the fall of 1973, when he offered me a cup of tea, a McVitie’s Digestive Biscuit and a lesson on monetary economics. He’s been watching Japanese policymaking for a long time.

According to John, the third arrow “consists of a long list of some 240 initiatives proposed by Prime Minister Shinzo Abe’s closest advisers as well as by government departments. Very little of substance has yet been implemented. The problem is that vested interests such as farmers, truckers and certain other groups of professionals have built strong political lobbies, and the PM has not felt able to confront them. It is largely for this reason that he called a new election of Japan’s lower House of Representatives [which Abe’s Liberal Democratic Party won in December]. Until Abenomics starts to show significantly better results, the Japanese economy is likely to languish, though not necessarily in the somnolent state that it had fallen into before Mr. Abe became PM.”

The traders seem to agree. They assigned a 3-out-of-4 probability to Japan’s growth rate falling below 2 percent for the first half of this year, with a 1-in-3 risk that it will expand by less than 1 percent, a chastened realization that growth expectations for the major economies are diverging as much as credit risks are widening among emerging markets.

James Shinn is lecturer at Princeton University’s School of Engineering and Applied Science ( and chairman of Teneo Intelligence. After careers on Wall Street and Silicon Valley, he served as national intelligence officer for East Asia at the Central Intelligence Agency and as assistant secretary of defense for Asia at the Pentagon. He serves on the boards of CQS, a London-based hedge fund, and Predata, a New York–based predictive analytics firm, and serves on the advisory board of Kensho, a Cambridge, Massachusetts–based financial analytics firm.