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Morning Update

Debt repayments faced by local Chinese governments, minutes published from the Federal Reserve's December policy meeting, and PMI releases today.


In China, 2024 is going to be the year to juggle finances as local governments face debt repayments of more than 650bn Dollars.

It has long been known that local authorities in China have borrowed vast sums of money in order to finance infrastructure projects, using off balance sheet entities know as local government financing vehicles (LGFVs), and that these infrastructure investments might not provide the returns needed to pay down the debt accumulated to build them.

As with most things financial in China, it isn’t immediately clear what the total size of the LGFV debt pile is, but best estimates suggest around 9 trillion dollars might be about right.

So why is this a problem now? Well it’s a question of size. With some $650bn due to be repaid this year and the cashflow not likely to be there to repay it, then the local governments that own the LGFVs are either going to have to default or restructure.

Default would probably lead to a load of market volatility and investors selling out of corporate debt and buying much safer government debt, which would increase borrowing costs, slow down corporate investment and weaken consumer demand, which would be bad for GDP, which would be bad for the nation – you see the picture.

Restructuring debts of this size isn’t easy and probably not something that local governments can do on their own – requiring the central government to help them out. In bringing in central government, any restructuring is going to come with strings attached and plenty of purse string tightening imposed on local governments, which will dampen their autonomy but also reign in their spending, which is likely to impact output.

China needs economic growth and though GDP is forecast to grow at 4.5% this year either of the above scenarios could wipe a percentage point off of this number and if there is further contagion from a default scenario that could be reduced by as much as 2%, which sounds small, but really isn’t.

Federal Reserve Minutes

Yesterday the Federal Reserve published the minutes from their latest December policy meeting. Here, the Federal Reserve met market expectations in maintaining their benchmark policy target rate of 5.25-5.5% – its highest level in 22 years. This marked the third consecutive hold as inflation figures (released the day before), showed US CPI slowing to its lowest level in five months at 3.1%. While this demonstrated that monetary tightening is helping to combat inflation, it nonetheless remains 1.1 percentage points over their target 2% rate.

With monetary conditions being at their highest level in years across the States, the minutes saw how “participants viewed the policy rate as likely at or near its peak for this tightening cycle, though they noted that the actual policy path will depend on how the economy evolves”. The further stated that restrictive policy stance to continue to soften household and business spending, helping to promote further reductions in inflation over the next few years.

A disparity exists however between the Fed and the market over the extent of rate cuts this year. For example, according to the Fed’s dot plot released at the December meeting, the majority of policy makers generally saw at least 75bps of cuts over 2024. Presently however, the market is pricing in around double the number of rate cuts, seeing 1.5 percentage points of rate cuts this year. This would see the Fed end 2024 with their benchmark policy rate at 3.75%-4.00%. Hence, given this gulf, markets will be keeping a close eye on any rhetoric from FOMC policy makers, to gain further insight into where they see the Fed’s monetary loosing path.

Regarding growth, policy makers said that they were forecasting 2.4% growth over the year, marking a 0.3 percentage point increase from their forecasts cast in September. Here, the minutes stated that “participants generally judged that, in 2024, real GDP growth would cool and that rebalancing of the labor market would continue, with the unemployment rate rising somewhat from its current level”.

Today’s Data

Today’s main data will be focused on PMI releases across the Eurozone, UK and US. Here, markets will be looking to gain some indication over the health of these economies in the last month of 2023. 1300 will also see the release of German inflation, where the general market consensus is forecasting a CPI print 3.8%.

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