Morgan Stanley: Is the U.S.-China summit a turning point or wishful thinking?
Hello everyone, I am Xing Zhiqiang, Robin. Today, the topic we will discuss is: Can China and the U.S. turn things around or is it wishful thinking? We will focus on three aspects: first, the situation of U.S.-China trade negotiations; second, the timing and specific planning of stimulus policies after the domestic Politburo meeting; third, how Chinese corporate strategies and industrial policies respond to the significant impact of tariffs and the new developments in supply-side reform 2.0, expanding domestic demand, and the strategy of going global.
To this end, I have invited Chief Strategist Laura, Chief Rachel from the basic raw materials sector, and Chinese economist Zheng Ning.
Since April 2, the global tariff war has led to a sharp increase in market volatility. The U.S. market has frequently experienced roller coaster-like fluctuations of falling and then rising over the past three to four weeks, with multiple incidents of simultaneous declines in stocks, bonds, and currency. Global investors are quite anxious. During this period, Laura and I communicated with major investors in the U.S. in New York and Boston, then returned to Hong Kong to talk with Asian hedge funds, and held discussions in Beijing with institutional and academic circles. Last week, we also communicated with local investors, policymakers, and manufacturing enterprises in India. Overall, everyone is very concerned about the impact of tariffs on the economy, the policy responses of various countries, and the future trends of economic changes.
Let’s first discuss the impact of tariffs on the economies of China, the United States, and Asian countries. After detailed calculations, it must be objectively recognized that the short-term impact of tariff escalations on the Chinese economy is quite severe. For the whole year, tariff escalations may lead to a GDP decline of about 0.9 percentage points for China. Even if more stimulus policies are introduced later, including possibly an additional 1 trillion to 1.5 trillion yuan in supplementary stimulus in the second half of the year, it can only partially offset the impact of tariffs. Therefore, in the past two to three weeks, we have lowered our full-year GDP growth forecast for China from 4.5% to 4.2%. Analyzing the quarterly trend, the GDP growth rate of 5.4% in the first quarter had some pre-emptive factors, and it is expected to decrease subsequently, with the fourth quarter's year-on-year growth possibly falling below 4%. There are already clear signs of slowing GDP growth in the second quarter, possibly dropping to 4.5%.
Some high-frequency data indicate economic changes. For example, since April, the number of Chinese container bookings to the U.S. has dropped sharply by 64%, leading to a decline in freight rates on West Coast routes; the PMI for emerging industries has seen the largest single-month drop since the pandemic; a survey of over 2,000 consumers shows that consumer confidence has weakened since April, with an increasing proportion of people worried about employment, much of which is related to the reduction of export and manufacturing jobs due to tariffs. Affected by subsidies and the pre-issuance of local bonds, sales of products such as automobiles, home appliances, and mobile phones saw a small spring surge from January to March, but this situation changed after April, which is one of the reasons for the expected decline in GDP growth in the second quarter.
The U.S. economy is also not optimistic and is currently on the edge of a cliff. Michael Gapen, the chief economist of the U.S., believes that although the U.S. economy has not yet entered a recession, it is very close, with a 50-50 probability of economic recession and possibly zero growth in the first quarter. The economy was already in such a state before the tariffs officially took effect; if tariffs remain high for a long time, it will severely undermine the confidence of businesses and consumers, potentially triggering a negative feedback loop of declining asset prices. The short-term stimulus policy efforts in the U.S. are insufficient, and in terms of finances, the efficiency reforms of the federal government have limited savings, making it difficult to find room for tax cuts in the short term. Meanwhile, the Federal Reserve may delay interest rate cuts longer than the market expects due to concerns over rising inflation caused by tariffs.
The entire Asian economy will be affected, as many Asian economies are dominated by foreign trade, such as South Korea, Thailand, Malaysia, and Taiwan, which are significantly impacted by the tariff war and the risk of U.S. economic recession. The overall economic growth in Asia is expected to slow from 4.8% in the fourth quarter of last year to 3.6% in the fourth quarter of this year. In comparison, India and Australia are less affected. In response to this situation, many Asian countries are adopting interest rate cuts, with some countries averaging cuts of 50 to 150 basis points, while China relies more on fiscal policy, with monetary policy primarily playing a supportive role in boosting confidence.
After the domestic Politburo meeting, China's response measures are as follows: The decision-making level set the tone for the second quarter, accelerating the implementation of the 2 trillion yuan broad fiscal expansion approved by the two sessions, speeding up local bond issuance, and appropriately lowering the reserve requirement and interest rates. It is expected that there will be a space for interest rate reduction of about 15 basis points in the second quarter, mainly used to boost confidence. At the same time, relending and targeted credit tools will be introduced to support scientific and technological innovation and consumption, although these tools have a relatively indirect effect. People are more optimistic about fiscal policy; according to the tone of the Politburo meeting, existing policy tools will be used first in the second quarter, and a supplementary budget of 1 trillion to 1.5 trillion yuan may be introduced in the second half of the year. However, if the economic data in May and June declines significantly, policy efforts may be intensified in advance. Regarding real estate policy, there were not many new statements in this Politburo meeting, which is relatively conservative and differs from the market's previous expectations. The meeting also proposed returning employment funds, but currently, it is estimated to account for less than 0.1 percentage points of GDP, and whether the scale will be increased in the future remains to be observed.
In the U.S.-China trade game, some believe that the U.S. is more dependent on China, as for some Chinese export products to the U.S., it is difficult for the U.S. to quickly find alternative suppliers. However, in reality, from a data perspective, the impact of U.S. reliance on Chinese imports on its core inflation is not much different from China's reliance on exports to the U.S. for domestic employment. The key lies in who can better alleviate these shocks through policy. The U.S. policy space is limited; if China can promptly launch policies to assist employment and expand domestic demand, it is expected to gain an advantage in the game and should not overly downplay the risks.
From a longer-term perspective, the recent phenomenon of simultaneous declines in U.S. stocks, bonds, and currency has affected the long-term dominance of the U.S. dollar as a reserve currency and the notion of U.S. economic exceptionalism. The global definition of safe-haven assets has changed, with safe-haven funds flowing into gold, cash, yen, and euros, leading to a net outflow of funds from U.S. Treasury bonds. This indicates a reevaluation of the dollar's safe-haven attributes. Although no currency can fully replace the dollar at present, the international status of the dollar has begun a long-term downward trajectory. If Europe achieves economic unity and China deepens reform and opening up, the status of the euro and the renminbi in the international reserve currency system is expected to gradually rise. The enhancement of the renminbi's international status depends on the intensity of China's reform and opening up, and the current situation provides China with a strategic window.
China should transition from a supply-driven development model to an internal demand and consumption-driven model. The "Two Zero Three Zero" strategy for the Chinese market should be launched, aiming to expand the domestic consumption market by 30% within the next five years, while gradually reducing external tariffs, market access thresholds, and industry subsidies to zero. The development of internal demand will be promoted through reforms in the social security system. The Politburo meeting proposed ideas for opening up and service industry access, hoping to implement the "Two Zero Three Zero" strategy. In fact, China already possesses advantages in industrial chain clusters, an engineer dividend, and a rich ecological application system, making it indispensable in the global technological revolution even without industry subsidies. Subsidies may instead provide other countries with an excuse to restrict Chinese products. In this process, although there are risks from some economies following the U.S. against China, we need not worry too much, as economies with close geopolitical ties to the U.S., such as Japan and South Korea, are still the minority.
