WEBVTT NOTE Created by CaptionSync from Automatic Sync Technologies www.automaticsync.com 00:00:01.176 --> 00:00:04.856 align:middle >> You're listening to All the Credit, a monthly podcast series brought to you 00:00:04.856 --> 00:00:09.406 align:middle by PGIM Fixed Income, an active, global, fixed income investment manager. 00:00:10.886 --> 00:00:15.206 align:middle >> Hey everyone, this is Tom Porcelli, chief U.S. economist at PGIM Fixed Income. 00:00:15.446 --> 00:00:18.006 align:middle Thank you for joining another episode of All the Credit. 00:00:18.146 --> 00:00:21.586 align:middle I'm happy to have Shekabe Faruki [phonetic] with me. 00:00:21.706 --> 00:00:24.536 align:middle Shekabe is our lead EM Asia economist. 00:00:24.536 --> 00:00:28.966 align:middle He joined us relatively recently, has been an absolute fantastic addition to the team. 00:00:28.966 --> 00:00:31.846 align:middle So, Shekabe, thanks for spending a little bit of time with us here today. 00:00:32.386 --> 00:00:35.076 align:middle >> Thanks Tom, and thanks for having me and happy new year. 00:00:35.286 --> 00:00:37.956 align:middle There's a fair bit going on in China and lots to talk about, 00:00:37.956 --> 00:00:40.566 align:middle so I'm really looking forward to our conversation today. 00:00:40.996 --> 00:00:44.666 align:middle >> Yeah, and Shekabe, the thing that I always worry about when there's a lot to talk about is 00:00:44.666 --> 00:00:46.596 align:middle in so many ways we're going to be scratching the surface, 00:00:46.596 --> 00:00:49.156 align:middle which I think our regular listeners appreciate. 00:00:49.156 --> 00:00:52.656 align:middle But what I like to say is this then is just an opportunity for people to ping us 00:00:52.656 --> 00:00:54.416 align:middle if they have any questions or follow-ups. 00:00:54.756 --> 00:00:58.516 align:middle And Shekabe is more than happy to have any additional conversations. 00:00:58.736 --> 00:01:00.426 align:middle But you're right, there's a lot to get into here. 00:01:00.766 --> 00:01:05.446 align:middle I think our regular listeners know that we take a probabilistic approach to forecasting, 00:01:05.686 --> 00:01:08.786 align:middle so we create plausible scenarios for the coming 12 months 00:01:09.036 --> 00:01:11.586 align:middle and then we assign a probability to each of those scenarios. 00:01:11.586 --> 00:01:15.456 align:middle In the U.S., we expect continued economic expansion over the forecast horizon, 00:01:15.456 --> 00:01:17.646 align:middle with fat tails, which is something we've been flagging, 00:01:17.646 --> 00:01:19.526 align:middle basically for the better part of the last year. 00:01:19.716 --> 00:01:25.046 align:middle And so, Shekabe, I think a good starting point is to walk through some of your scenarios 00:01:25.166 --> 00:01:27.186 align:middle as it relates to China in the coming year. 00:01:27.186 --> 00:01:30.236 align:middle So we'll keep it high level and then we'll sort of drill in as necessary. 00:01:30.466 --> 00:01:34.736 align:middle I will say, yes, we will definitely get into tariffs and China reaction function. 00:01:34.736 --> 00:01:37.016 align:middle I think it's probably worth starting at the beginning. 00:01:37.446 --> 00:01:39.976 align:middle So Shekabe, give us what you're thinking over the next 12 months. 00:01:40.746 --> 00:01:42.056 align:middle >> Yeah sure, it sounds good, Tom. 00:01:42.266 --> 00:01:47.496 align:middle So let me start with a broad base from then how we see 2025 shaping up for China. 00:01:47.496 --> 00:01:52.406 align:middle Obviously tariffs and their response to the tariffs is going to be a big theme within that. 00:01:52.406 --> 00:01:57.296 align:middle But before we get into that, maybe let's just sort of lay the ground on where China is. 00:01:57.616 --> 00:02:01.816 align:middle So I think it's clear that China needs to address its demand and financial 00:02:01.816 --> 00:02:07.076 align:middle and fiscal imbalances this year, which is structural in nature, and they go to the core 00:02:07.076 --> 00:02:10.136 align:middle of China's local government and SOE-led growth model. 00:02:10.606 --> 00:02:15.076 align:middle They need to raise private sector confidence and they need to allow the property sector to heal. 00:02:15.446 --> 00:02:18.896 align:middle Without this, China I think will only entrench itself 00:02:18.986 --> 00:02:22.226 align:middle in a deflationary [inaudible] recession liquidity trap. 00:02:22.586 --> 00:02:28.306 align:middle Now, in terms of what you were saying, so when we think about sort of the five scenarios 00:02:28.306 --> 00:02:31.416 align:middle that can potentially play out in the baseline, 00:02:31.486 --> 00:02:37.756 align:middle we are thinking of China returning growth in the low 4s. 00:02:38.316 --> 00:02:43.626 align:middle People who follow China closely will appreciate that China anchors itself to a growth target, 00:02:44.086 --> 00:02:50.766 align:middle and although potential growth in China has been slowing over the years, there is a reluctance 00:02:50.886 --> 00:02:54.886 align:middle from Beijing to drop the 5% growth target. 00:02:54.886 --> 00:03:00.986 align:middle So the language around that has been changing over the years, and 2024 was around 5%. 00:03:01.256 --> 00:03:04.136 align:middle There are rumors that they're going to keep this target. 00:03:04.136 --> 00:03:10.326 align:middle Now we think that more realistic target in the current economic environment is one of around 4 00:03:10.326 --> 00:03:16.486 align:middle and 1/2 percent, and to signal the difficulties at achieving that 4 and 1/2 percent 00:03:16.486 --> 00:03:20.766 align:middle and the downside risks to it, in the baseline we expect China 00:03:20.866 --> 00:03:24.776 align:middle to potentially return around 4.2% in the baseline. 00:03:24.776 --> 00:03:26.996 align:middle Now, how do we think about the baseline? 00:03:26.996 --> 00:03:29.326 align:middle So, you know at this point we've got to bring in the U.S. 00:03:29.326 --> 00:03:31.976 align:middle and what the U.S. is going to do on the tariffs front. 00:03:32.286 --> 00:03:33.716 align:middle >> Let me just interrupt you for a quick sec. 00:03:33.826 --> 00:03:36.326 align:middle So our baseline is for continued expansion 00:03:36.326 --> 00:03:38.366 align:middle and what percentage probability do we assign to that? 00:03:39.006 --> 00:03:43.126 align:middle >> Yeah, so Tom, we basically are characterizing the baseline as a soft landing. 00:03:43.126 --> 00:03:47.626 align:middle In the context of China we're assigning a 65% probability to that. 00:03:47.626 --> 00:03:51.936 align:middle And the way we think about the economic environment that China will face 00:03:51.936 --> 00:03:57.716 align:middle in that soft landing is that from the U.S. side, without going into sort of details 00:03:57.716 --> 00:04:02.346 align:middle about the quantity of the tariffs that come through, we think of the U.S. continuing 00:04:02.346 --> 00:04:05.776 align:middle to pursue what we call a de-risking plus strategy. 00:04:05.776 --> 00:04:12.386 align:middle So the way that we've characterized the U.S. policy towards China is you're in three worlds; 00:04:12.386 --> 00:04:17.586 align:middle you're either de-risking, or you're de-coupling, or you're looking for a trade deal. 00:04:17.726 --> 00:04:21.536 align:middle So in the soft landing we'll be in a de-risking plus environment. 00:04:21.796 --> 00:04:26.636 align:middle The other scenarios that we've got are stagflation, which in our minds is one 00:04:26.636 --> 00:04:28.396 align:middle of the least likely environments. 00:04:28.396 --> 00:04:30.946 align:middle We're assigning a 5% probability to that. 00:04:31.256 --> 00:04:34.766 align:middle Stagnation, slightly high probability at 10%. 00:04:34.766 --> 00:04:39.146 align:middle And then we run a nominal GDP boom scenario where we think of that 00:04:39.146 --> 00:04:43.056 align:middle as China pursuing a nominal GDP target. 00:04:43.326 --> 00:04:46.766 align:middle At this stage we're only assigning a 5% probability to that. 00:04:46.766 --> 00:04:52.106 align:middle And then we've got the roaring '20s in which we expect China to kind of pan a deal 00:04:52.106 --> 00:04:56.236 align:middle with the U.S., fix some of this local government funding constraints 00:04:56.236 --> 00:04:57.976 align:middle and start crowding in the private sector. 00:04:58.056 --> 00:05:00.396 align:middle And we're assigning a 15% probability to that. 00:05:00.396 --> 00:05:05.306 align:middle But going back to the soft landing, basically what we're looking for is 00:05:05.396 --> 00:05:08.716 align:middle that China stays the course on industrial policy. 00:05:09.026 --> 00:05:12.206 align:middle It gradually eases off excess capacity and responds 00:05:12.206 --> 00:05:17.016 align:middle with calibrated demand side stimulus measures, and within that we think stepping up support 00:05:17.016 --> 00:05:21.956 align:middle to the consumers, property sector, and infrastructure, to offset the demand shock 00:05:21.956 --> 00:05:27.156 align:middle that comes from the U.S. We think that China in this scenario ends up injecting 00:05:27.156 --> 00:05:29.736 align:middle in that fiscal impulse of at least 2%. 00:05:29.736 --> 00:05:34.376 align:middle But as I mentioned earlier is tolerant to a lot of growth target of around 4 and 1/2 percent. 00:05:34.876 --> 00:05:38.446 align:middle >> How does that 2% compare to market expectations now? 00:05:39.246 --> 00:05:42.036 align:middle >> Market expectations have been moving quite rapidly. 00:05:42.066 --> 00:05:44.916 align:middle I would say that initially when we started thinking about this, 00:05:44.916 --> 00:05:49.786 align:middle we were probably on the more expansionary side with our 2% forecast. 00:05:49.976 --> 00:05:54.626 align:middle The market was closer to a net injection of 1% of fiscal impulse. 00:05:54.626 --> 00:05:57.546 align:middle But now the market is moving towards 2%. 00:05:57.826 --> 00:05:59.476 align:middle >> Oh, that's priced in then, at this point. 00:05:59.736 --> 00:06:01.936 align:middle >> Yeah. So it's priced in in the sense that it's 00:06:01.936 --> 00:06:05.936 align:middle within the expectations of professional forecasters. 00:06:05.936 --> 00:06:10.516 align:middle It's difficult to say if it's priced into the rates and effects market. 00:06:10.516 --> 00:06:15.026 align:middle Because there's other factors that will determine pricing in those markets, right? 00:06:15.086 --> 00:06:17.856 align:middle But it is becoming more of a consensus take. 00:06:17.856 --> 00:06:23.366 align:middle Now, obviously it will depend on the exact magnitude and the modalities 00:06:23.366 --> 00:06:25.256 align:middle of the tariffs as they come through. 00:06:25.256 --> 00:06:31.616 align:middle So for us, the 2% is a starting point which we think that the Chinese will need to, 00:06:31.616 --> 00:06:38.026 align:middle and will ramp up if the severity of the tariffs is much larger or more biting in actuality. 00:06:38.776 --> 00:06:43.446 align:middle >> One of the things that you mentioned earlier that I think we should come back to is this idea 00:06:43.446 --> 00:06:48.846 align:middle that you need to raise private sector confidence and you need the property sector to heal. 00:06:48.846 --> 00:06:52.566 align:middle So, within the context of what you just mentioned, how do they address that? 00:06:53.396 --> 00:06:58.316 align:middle >> Yeah, so in a nutshell I think the property sector needs quasi fiscal support at this stage. 00:06:58.496 --> 00:07:04.096 align:middle When you have housing crisis of the nature, I mean this is self-induced to an extent, right? 00:07:04.096 --> 00:07:09.996 align:middle So back in 2018-19, Beijing identified the property sector as a source 00:07:09.996 --> 00:07:12.776 align:middle of macro imbalances that it wanted to address. 00:07:12.776 --> 00:07:16.946 align:middle And it started addressing those with heavy regulatory clamp down. 00:07:16.946 --> 00:07:21.206 align:middle And so it's been a few years in the making with three or four years in, 00:07:21.616 --> 00:07:26.066 align:middle has had massive effects on consumer confidence on shore. 00:07:26.416 --> 00:07:31.606 align:middle It's been a store of wealth for Chinese household given how repressed other financial 00:07:31.606 --> 00:07:32.826 align:middle markets in China are. 00:07:33.046 --> 00:07:37.736 align:middle So, because they're not allowing a proper pricing signal to go through. 00:07:37.736 --> 00:07:42.396 align:middle Now if you look at sort of the housing market crisis in other economies, like Japan, 00:07:42.396 --> 00:07:46.726 align:middle or the U.S., or Spain, it takes at least five or six years to clear, 00:07:46.726 --> 00:07:50.946 align:middle and that's when you have proper pricing signals working their way through, right? 00:07:50.946 --> 00:07:54.116 align:middle And in China you've not allowed that to happen. 00:07:54.516 --> 00:08:00.206 align:middle So at this point, the only way that you can provide a sort of a credible flaw 00:08:00.206 --> 00:08:04.426 align:middle to what is happening, is to provide government sector support, 00:08:04.946 --> 00:08:10.726 align:middle and then as the property sector overhang starts to clear, then you get a situation 00:08:10.726 --> 00:08:15.406 align:middle where hopefully that starts feeding into better consumer confidence, at least if not, 00:08:15.406 --> 00:08:17.196 align:middle sort of private sector confidence. 00:08:17.836 --> 00:08:20.126 align:middle >> And in China private government sector support 00:08:20.126 --> 00:08:22.756 align:middle for that sector means encouraging lending? 00:08:23.346 --> 00:08:28.256 align:middle >> So yeah, what they've been trying to do is to white list property developers that you can, 00:08:28.256 --> 00:08:31.216 align:middle and then the other side of that is developers that you [inaudible]. 00:08:31.396 --> 00:08:37.076 align:middle But the messaging on that hasn't been very clear, so we've just ended up in this situation 00:08:37.076 --> 00:08:40.306 align:middle where there's no lending to the property sector going on at the moment. 00:08:40.306 --> 00:08:45.576 align:middle But then when property developers are unable to deliver on new starts, 00:08:45.576 --> 00:08:51.096 align:middle then there's the other side of this which is that people who have put down down payments, 00:08:51.246 --> 00:08:54.916 align:middle they're not getting delivery on those properties, they don't want to pay, 00:08:54.996 --> 00:08:58.496 align:middle they don't want to chuck good money off potentially what could be a 00:08:58.496 --> 00:09:00.376 align:middle nondeliverable asset. 00:09:00.446 --> 00:09:06.316 align:middle So the only way that you can resolve that is for the government to provide lending 00:09:06.316 --> 00:09:11.986 align:middle and to provide money to finalize those existing projects and start buying 00:09:11.986 --> 00:09:14.676 align:middle up excess capacity within the system. 00:09:15.196 --> 00:09:18.506 align:middle >> Correct me if I'm wrong, but prices are down like 30% from the peak, 00:09:18.506 --> 00:09:20.976 align:middle or something along those lines, if I'm not mistaken. 00:09:21.356 --> 00:09:27.826 align:middle So the thought process then is, okay, fix or try to fix, or try to shore up this one sector 00:09:27.826 --> 00:09:32.196 align:middle which probably represents, for most people, their biggest asset and then that feeds 00:09:32.196 --> 00:09:37.706 align:middle into this idea of stabilizing confidence at the consumer level. 00:09:37.796 --> 00:09:40.086 align:middle And again, I have sympathy for that general blow through, 00:09:40.086 --> 00:09:42.706 align:middle but I guess the bigger question then is, but how long does that take? 00:09:42.916 --> 00:09:46.996 align:middle I mean, that's not something a year in the making, as you rightly highlighted. 00:09:46.996 --> 00:09:49.566 align:middle I mean it could take years, as it did in the United States. 00:09:49.876 --> 00:09:53.966 align:middle So when I think about your soft landing scenario, that 65%, 00:09:53.966 --> 00:09:59.326 align:middle I would think that almost none of that healing, right, related to housing and the feed 00:09:59.326 --> 00:10:01.776 align:middle through into the consumer, is embedded in that idea. 00:10:01.776 --> 00:10:05.456 align:middle I mean this sounds like something maybe for the next two or three years out, or even beyond. 00:10:06.286 --> 00:10:10.736 align:middle >> I think it is going to be a multi-year process, but I think we're in an environment 00:10:10.736 --> 00:10:16.296 align:middle where we are two or three years into this already and as you mentioned, past prices, 00:10:16.296 --> 00:10:18.706 align:middle where they've been allowed to adjust. 00:10:18.706 --> 00:10:21.466 align:middle So a lot of the pricing adjustment that we've seen is 00:10:21.466 --> 00:10:25.206 align:middle in secondary homes, not in primary new starts. 00:10:25.206 --> 00:10:29.336 align:middle So, if they allow some adjustments to come through on the primary new starts, 00:10:29.616 --> 00:10:35.856 align:middle if they allow some clearing to happen via local government or central government supports, 00:10:35.886 --> 00:10:37.876 align:middle then you'll instill some confidence. 00:10:37.916 --> 00:10:43.456 align:middle But there's estimates out there that this overhang, in terms of housing capacity is two 00:10:43.456 --> 00:10:48.166 align:middle or three years' worth of excess capacity, so you can't take that out in a year. 00:10:48.166 --> 00:10:51.946 align:middle But, what we basically need is, what we're really seeing 00:10:51.946 --> 00:10:56.966 align:middle over the past couple years is sustained declines in the property sector sales. 00:10:57.306 --> 00:10:59.376 align:middle And that needs to calm down a bit. 00:10:59.626 --> 00:11:04.626 align:middle So we may not go to positive sales or new investment in property, 00:11:04.626 --> 00:11:10.386 align:middle but as long as there's a bit of a clear up in that process, where local governments are able 00:11:10.386 --> 00:11:16.476 align:middle to then sell new land and they're not fully reliant on the proceeds, 00:11:16.676 --> 00:11:22.206 align:middle property developers are somewhat made whole or they can make local governments whole, 00:11:22.206 --> 00:11:24.356 align:middle then I think that's a better environment. 00:11:24.996 --> 00:11:28.596 align:middle >> So fair to say then, that, and we'll leave tariffs off to the side, 00:11:28.596 --> 00:11:31.136 align:middle we'll get to that in a second, but is it fair to say that just 00:11:31.136 --> 00:11:33.206 align:middle from a fundamental economic perspective, 00:11:33.206 --> 00:11:39.016 align:middle that this is if not the single biggest challenge in China, certainly one of them? 00:11:39.606 --> 00:11:42.546 align:middle >> Yeah, so on the domestic side this is the biggest challenge. 00:11:42.546 --> 00:11:47.536 align:middle And the feed through into local government finances and the debt overhang 00:11:47.536 --> 00:11:50.376 align:middle on the local government side is the other big challenge. 00:11:50.376 --> 00:11:54.946 align:middle So, the main issue with China's growth model, aside from its, 00:11:54.946 --> 00:12:00.116 align:middle in the past being very export oriented and dependent on SOEs. 00:12:00.116 --> 00:12:06.946 align:middle On the domestic side, you just don't have the right fiscal transfer mechanism set up, 00:12:06.946 --> 00:12:13.036 align:middle and therefore local governments have overly relied in the past on borrowing 00:12:13.126 --> 00:12:17.786 align:middle and then spending on infrastructure and on the property sector. 00:12:17.786 --> 00:12:21.596 align:middle So, without clearing up the overhang in the property sector, 00:12:21.746 --> 00:12:23.926 align:middle basically everything's come to a standstill. 00:12:24.016 --> 00:12:28.876 align:middle You put the brakes on the economy because effectively we're in a liquidity trap right now. 00:12:28.876 --> 00:12:34.396 align:middle Because any money and any new liquidity that's being generated by the PBoC is going 00:12:34.396 --> 00:12:38.336 align:middle to [inaudible] existing projects and bad loans, et cetera. 00:12:38.336 --> 00:12:40.286 align:middle So you need to move away from that. 00:12:40.286 --> 00:12:44.826 align:middle And the only way that you can really do that is to address the property sector. 00:12:45.476 --> 00:12:48.886 align:middle >> Everything you've said thus far really just drives home 00:12:48.916 --> 00:12:50.446 align:middle that they're going to be spending a lot. 00:12:50.686 --> 00:12:55.336 align:middle I mean you cannot do this without what sounds like a pretty big fiscal impulse. 00:12:55.706 --> 00:12:56.806 align:middle How do they support that? 00:12:56.956 --> 00:12:59.116 align:middle How are they able to finance this? 00:12:59.206 --> 00:13:02.386 align:middle To me, in the United States we're dealing with this challenge right now. 00:13:02.536 --> 00:13:06.906 align:middle The Trump Administration obviously has some big plans, or has at least stated big plans, 00:13:07.156 --> 00:13:11.506 align:middle but they're already starting to see some pushback from fiscal conservatives in DC. 00:13:11.766 --> 00:13:13.996 align:middle What is the setup for that in China? 00:13:14.646 --> 00:13:17.866 align:middle >> So, the way that they've been dealing with this in the past, and I think they'll continue 00:13:17.866 --> 00:13:21.556 align:middle to follow the same model, is liquidity provisioning 00:13:21.556 --> 00:13:25.176 align:middle from the PBoC that directly or indirectly. 00:13:25.176 --> 00:13:32.556 align:middle So, indirectly reserve ratios in China are super high, relative to developed markets. 00:13:32.556 --> 00:13:38.156 align:middle So, if you look at reserve requirements within the banking system in China, the top six banks, 00:13:38.156 --> 00:13:43.946 align:middle they have to park 7- or 8% of their deposits in terms of reserve requirements now. 00:13:43.946 --> 00:13:48.876 align:middle Obviously you can speak to this better than I can, Tom, but in the U.S. or in Europe, 00:13:48.876 --> 00:13:52.176 align:middle those reserve requirements are close to zero at this stage, right? 00:13:52.176 --> 00:13:56.926 align:middle So, the question is, in the current setup do banks really need to be putting aside 00:13:56.926 --> 00:14:00.016 align:middle so much money in sort of precautionary safeguards? 00:14:00.346 --> 00:14:06.466 align:middle And in the case of China, for every 50 basis points of reserve requirement cuts, 00:14:06.466 --> 00:14:08.836 align:middle you end up really seeing roughly 00:14:08.836 --> 00:14:12.686 align:middle around $1 trillion [inaudible] worth of liquidity into the system. 00:14:12.956 --> 00:14:16.116 align:middle So that's one way that they've been going about it. 00:14:16.116 --> 00:14:22.156 align:middle And then, I think the Chinese would never want to do QE in the sense of calling it QE, 00:14:22.156 --> 00:14:29.456 align:middle but what we are seeing is the PBoC has been over the years, injecting liquidity, so it takes on, 00:14:29.456 --> 00:14:34.216 align:middle it's effectively the balance sheet, the PBoC's own balance sheet has been expanding 00:14:34.216 --> 00:14:36.456 align:middle and it needs to continue to expand. 00:14:36.846 --> 00:14:40.936 align:middle Now, because of the way that the fiscal is set up in China, 00:14:41.486 --> 00:14:46.886 align:middle most of the fiscal spend has happened through local governments and they've done all 00:14:46.886 --> 00:14:50.066 align:middle of the borrowing and some of this has been off balance sheet 00:14:50.066 --> 00:14:54.386 align:middle and that's why we've got a debt overhang in local government financing vehicles. 00:14:54.666 --> 00:14:59.066 align:middle So the central government balance sheet itself doesn't look that bad, 00:14:59.146 --> 00:15:02.216 align:middle relative to the end balance sheets. 00:15:02.476 --> 00:15:09.386 align:middle So what they can do, and this is where the focus is, that they can basically take on more 00:15:09.436 --> 00:15:13.616 align:middle on the central government balance sheet, but ultimately they will need liquidity support 00:15:13.616 --> 00:15:19.066 align:middle from the PBoC, either directly from the PBoC or indirectly through the release 00:15:19.066 --> 00:15:20.976 align:middle of liquidity from the banking system. 00:15:21.126 --> 00:15:25.006 align:middle >> And of course that support from the PBoC, that's not in question. 00:15:25.326 --> 00:15:29.286 align:middle >> No, so this is a thing with the PBoC, they're never explicit about it in the sense 00:15:29.286 --> 00:15:33.006 align:middle of they're not going to come out like Mario Draghi did for example, 00:15:33.006 --> 00:15:37.396 align:middle they're not going to come out like the Fed did and say, we are pursuing QE. 00:15:37.536 --> 00:15:42.666 align:middle But actually in their actions they are doing quote-unquote, [inaudible] QE. 00:15:43.616 --> 00:15:45.736 align:middle >> Alright, we need to jump into the tariff conversation. 00:15:45.966 --> 00:15:48.276 align:middle I had a dinner with a few economists the other night. 00:15:48.276 --> 00:15:53.096 align:middle There was a great discussion around what we think going to happen in the United States, 00:15:53.096 --> 00:15:57.236 align:middle as relates to tariffs, and I think the consensus is, it's really hard to know with any level 00:15:57.236 --> 00:15:58.476 align:middle of detail what is going to happen. 00:15:58.476 --> 00:16:01.836 align:middle In fact, I think we were all in agreement that Trump doesn't know the details 00:16:01.836 --> 00:16:03.386 align:middle of what tariffs are going to look like. 00:16:03.386 --> 00:16:04.766 align:middle So, it's still an open question. 00:16:05.136 --> 00:16:08.066 align:middle Recently an article that came out, was in the Washington Post, 00:16:08.066 --> 00:16:09.496 align:middle said tariffs are going to be very targeted. 00:16:09.496 --> 00:16:12.376 align:middle And then Trump came out and said, it's not going to be that way. 00:16:12.796 --> 00:16:15.466 align:middle I think all we saw in that was the sausage making process. 00:16:15.646 --> 00:16:17.716 align:middle Displayed for us in the Washington Post. 00:16:17.946 --> 00:16:20.196 align:middle I think it's an open question of what it's going to look like. 00:16:20.356 --> 00:16:25.366 align:middle Our own view is tariffs are going to happen, it's just the degree to which they happen now. 00:16:25.896 --> 00:16:30.086 align:middle So, let's just assume that you do see tariffs on China, which again I think, 00:16:30.086 --> 00:16:31.776 align:middle I'm hardly going out on a limb by saying that. 00:16:31.956 --> 00:16:34.256 align:middle But, what do you think the reaction function is? 00:16:34.506 --> 00:16:39.206 align:middle Do they come back harder relative to what might get put on them from the U.S.? 00:16:39.476 --> 00:16:44.376 align:middle Or, is it an opportunity for Xi to almost present himself as the grownup 00:16:44.376 --> 00:16:50.126 align:middle in the room relative to Trump and say, well, let's take this in sort of an orderly fashion 00:16:50.126 --> 00:16:51.866 align:middle and let's have more discussion around it. 00:16:52.106 --> 00:16:54.726 align:middle I can see this going in an assortment of different directions 00:16:54.726 --> 00:16:56.846 align:middle but give us your sense for how this might go. 00:16:57.346 --> 00:17:01.966 align:middle >> I completely agree, I think in 2018-19, during the first round of tariffs 00:17:01.966 --> 00:17:07.036 align:middle on the Trump one, that is exactly how Xi decided to portray himself in China. 00:17:07.086 --> 00:17:11.676 align:middle In terms of the responses that we saw back then, they were highly measured 00:17:11.676 --> 00:17:14.466 align:middle to the proportionate, in a sense reactive. 00:17:14.616 --> 00:17:17.086 align:middle He always wanted Trump to make the first move. 00:17:17.266 --> 00:17:21.246 align:middle And I think we're going to see a similar set up this time round. 00:17:21.466 --> 00:17:26.686 align:middle Now, as you mentioned, we're all trying to read the tea leaves, right, in terms of will they, 00:17:26.686 --> 00:17:29.536 align:middle won't they, symmetric, asymmetric, how severe. 00:17:29.726 --> 00:17:34.056 align:middle But I think it's fair to assume that we will see tariffs against China. 00:17:34.376 --> 00:17:38.676 align:middle The kind of makeup as we know of the incoming administration suggests as much. 00:17:38.676 --> 00:17:44.916 align:middle So when I think about how the Chinese see this, I think there is an element from Trump 00:17:44.916 --> 00:17:47.766 align:middle with keeping everyone second guessing by design. 00:17:47.796 --> 00:17:49.426 align:middle Which works to his advantage. 00:17:49.766 --> 00:17:54.566 align:middle On the Chinese side, I think what we're seeing is a two-pronged [inaudible] policy strategy 00:17:54.566 --> 00:17:58.486 align:middle which is they're laying down red lines whilst indicating willingness 00:17:58.486 --> 00:18:00.786 align:middle to carve out deals to avoid tariffs. 00:18:00.886 --> 00:18:05.416 align:middle We've seen in the past that Trump is willing to carve out deals as well, and that's why, 00:18:05.416 --> 00:18:10.886 align:middle going back to that scenario so in the baseline 65% probability is on a soft landing. 00:18:10.886 --> 00:18:13.746 align:middle But then when we think about the tails splitting out, 00:18:13.826 --> 00:18:21.306 align:middle 35% we're putting on the margin a high probability on us carving out a deal rather 00:18:21.306 --> 00:18:23.476 align:middle than moving into the decoupling world. 00:18:23.476 --> 00:18:28.946 align:middle And then to your point about Xi being the grownup in the room, I think safeguards for him 00:18:28.946 --> 00:18:33.846 align:middle against all of this, and against the potential new cold war front in a sense, 00:18:33.846 --> 00:18:39.076 align:middle is to build momentum behind the global [inaudible] alternative and to show the world 00:18:39.076 --> 00:18:43.856 align:middle that he is the grownup in the room and China will follow the rules-based order 00:18:43.856 --> 00:18:45.766 align:middle and be more predictable than Trump. 00:18:46.006 --> 00:18:48.026 align:middle And as an interesting aside, you will have seen 00:18:48.026 --> 00:18:50.516 align:middle in the news his decision to join the BRICS, right? 00:18:50.516 --> 00:18:54.096 align:middle So I wouldn't say they're getting a lot of momentum, because there's still a lot 00:18:54.096 --> 00:18:57.836 align:middle of internal issues in that global south construct, 00:18:57.836 --> 00:18:59.606 align:middle but that's the way that he's pushing it, right? 00:18:59.606 --> 00:19:01.856 align:middle And then the other thing to look 00:19:01.856 --> 00:19:06.726 align:middle at at this current juncture is how [inaudible] is dealing with Europe's tariffs. 00:19:07.026 --> 00:19:13.736 align:middle So Europe conducted sort of an anti-subsidy investigation into China's behavior 00:19:13.736 --> 00:19:17.896 align:middle in the auto sector and the Chinese are now looking to strike a deal 00:19:18.096 --> 00:19:22.146 align:middle with the Biden Administration and kind of came straight ahead and said we're going 00:19:22.146 --> 00:19:25.756 align:middle to slap 100% tariffs on China's EV exports. 00:19:25.756 --> 00:19:30.666 align:middle Europe followed due process and talked about putting on a lower tariff, 00:19:30.666 --> 00:19:34.076 align:middle but the Chinese have come in and said look, we can agree on a deal 00:19:34.126 --> 00:19:40.066 align:middle where we regulate the quantum and the pricing of our exports into Europe 00:19:40.176 --> 00:19:44.176 align:middle to avoid Europe putting on tariffs against us, right? 00:19:44.176 --> 00:19:49.446 align:middle And additionally what they've done is in some of the overcapacity sectors, such as chemicals, 00:19:49.446 --> 00:19:54.726 align:middle et cetera, they're stepping down the subsidies so they're placing the exports rebates 00:19:54.726 --> 00:19:57.316 align:middle and subsidies that they give they're curtailing those. 00:19:57.316 --> 00:20:01.396 align:middle So it's not a full unwind of the subsidies but they're reducing the amount. 00:20:01.396 --> 00:20:04.586 align:middle So, there is an element of that that's playing out. 00:20:04.586 --> 00:20:09.196 align:middle And then in terms of what we're seeing from the Chinese right now is so steps 00:20:09.196 --> 00:20:11.426 align:middle in that direction in terms of foreign policy. 00:20:11.426 --> 00:20:15.066 align:middle And then on the domestic policy front, their safeguard is 00:20:15.066 --> 00:20:21.626 align:middle that they will be implementing what they call, counter-cyclical fiscal policy that will help 00:20:21.626 --> 00:20:24.836 align:middle to offset the gross drag from the tariffs as and when they come in. 00:20:25.166 --> 00:20:28.666 align:middle And then the other big question is, what are they going to do with the FX? 00:20:28.666 --> 00:20:31.546 align:middle Are they going to allow the currency to depreciate? 00:20:31.546 --> 00:20:33.596 align:middle Are they going to weaponize the currency? 00:20:33.596 --> 00:20:40.176 align:middle So on that front, if we go back to 2018-19, is telling because PBoC back then was reluctant 00:20:40.176 --> 00:20:45.546 align:middle to allow anticipatory moves in the currency, but ultimately it did allow the currency 00:20:45.546 --> 00:20:49.166 align:middle to proportionately adjust when concrete tariff measures came through. 00:20:49.166 --> 00:20:54.086 align:middle So what we've seen from official communication from the PBoC that it wants to keep a lid 00:20:54.086 --> 00:20:59.066 align:middle on currency adjustment for now, and having learned its lesson from 2015, 00:20:59.066 --> 00:21:01.696 align:middle we think that a step deval is unlikely. 00:21:01.696 --> 00:21:04.796 align:middle There has to have a preference for stability and we think 00:21:04.796 --> 00:21:07.866 align:middle that currency weaponization is likely a last resort. 00:21:08.376 --> 00:21:14.296 align:middle Over time they will allow the currency to adjust as the tariffs come in, but in an orderly way. 00:21:14.296 --> 00:21:18.716 align:middle On that actually, an interesting point is if you look at the FX options market you'll see 00:21:18.716 --> 00:21:21.036 align:middle that currently the bulk of the probability [inaudible] is 00:21:21.036 --> 00:21:23.256 align:middle for tariffs to kick in in early spring. 00:21:23.256 --> 00:21:26.676 align:middle And the currency to adjust to 7.5 but not beyond. 00:21:26.676 --> 00:21:31.616 align:middle And a lot of this market pricing is reminiscent of the 2018-19 playbook. 00:21:31.616 --> 00:21:33.256 align:middle >> And you agree with that, right? 00:21:33.256 --> 00:21:34.206 align:middle You agree with that timing? 00:21:34.806 --> 00:21:38.416 align:middle >> I think it's a fair assumption to see something come through around then. 00:21:38.616 --> 00:21:43.196 align:middle Although I guess recently [inaudible] focus on Canada, Greenland, all of that. 00:21:43.196 --> 00:21:46.066 align:middle So, I don't know, does that put China on the back burner? 00:21:46.066 --> 00:21:46.646 align:middle I don't know. 00:21:46.646 --> 00:21:48.076 align:middle But obviously we're keeping an eye on it. 00:21:48.076 --> 00:21:53.416 align:middle But one thing I would add, as much as the expected phased in adjustment on the currency, 00:21:53.416 --> 00:21:56.636 align:middle the adjustment may actually need to be larger this time round. 00:21:57.266 --> 00:22:02.306 align:middle >> If we were to stick with Trump and China, I think a fair question is, 00:22:02.456 --> 00:22:05.476 align:middle where does the relationship with Taiwan sit? 00:22:05.476 --> 00:22:10.746 align:middle Do you see that becoming an escalatory issue over the coming four years? 00:22:10.746 --> 00:22:13.736 align:middle Or do you think it could actually remain status quo? 00:22:14.006 --> 00:22:16.096 align:middle When you think about the geopolitical challenges, 00:22:16.096 --> 00:22:17.996 align:middle it's always part of the scenarios, right? 00:22:18.126 --> 00:22:19.976 align:middle Taiwan. What do you think happens over the coming four years? 00:22:20.066 --> 00:22:27.126 align:middle It's actually quite telling, so President Xi does this annual New Year's Day address, 00:22:27.266 --> 00:22:31.176 align:middle and there's a lot of focus on it this year for multiple reasons. 00:22:31.176 --> 00:22:36.336 align:middle One, to get a sense of where he is in terms of the growth outlook, the stimulus outlook. 00:22:36.466 --> 00:22:40.576 align:middle There's also people were looking at it to see what he would say about Taiwan, 00:22:40.576 --> 00:22:46.536 align:middle because if you kind of go through existing predictions, Beijing and Xi have made clear 00:22:46.536 --> 00:22:49.616 align:middle that at some point they do want to subsume Taiwan. 00:22:49.736 --> 00:22:51.926 align:middle And so the question is, when and how? 00:22:52.166 --> 00:22:56.526 align:middle And for a lot of fiscal experts that timeline starts in 2025. 00:22:56.526 --> 00:23:02.236 align:middle This is quite a wide timeline because [inaudible] it needs to be before 2037, 00:23:02.236 --> 00:23:03.996 align:middle but it can start starting this year. 00:23:04.306 --> 00:23:08.466 align:middle But if you look at the New Year's Day address, there's no new hints from Xi 00:23:08.636 --> 00:23:10.576 align:middle on what the plans are on this front. 00:23:10.576 --> 00:23:15.386 align:middle And similarly, if you look at the communication that's coming out of Taiwan, again, 00:23:15.416 --> 00:23:20.426 align:middle Taiwan's standing its ground, but there wasn't any new information per se. 00:23:20.426 --> 00:23:25.716 align:middle So I think both sides have taken a step back and waiting to see how this evolves under Trump. 00:23:25.866 --> 00:23:30.886 align:middle The one thing that we are seeing though is over the holiday period we saw a step 00:23:30.886 --> 00:23:36.836 align:middle up in Chinese military exercises over the Taiwan Strait, and this is quite indicative 00:23:36.886 --> 00:23:43.106 align:middle that China is effectively testing and it will ramp up these tests, testing its capabilities 00:23:43.106 --> 00:23:48.036 align:middle for a soft takeover that keeps it below the threshold [inaudible] of international rules 00:23:48.036 --> 00:23:52.666 align:middle of engagement, rather than an outright invasion, which would make it easier for Washington 00:23:52.666 --> 00:23:54.476 align:middle and allies to come to Taiwan's aid. 00:23:54.476 --> 00:23:59.676 align:middle And these military exercises, they are another indication of China testing its ability 00:23:59.676 --> 00:24:03.536 align:middle to encircle Taiwan effectively via maritime blockades. 00:24:03.536 --> 00:24:06.046 align:middle They're playing around with advanced cyber warfare. 00:24:06.356 --> 00:24:09.076 align:middle So you effectively cut Taiwan off from seaborne trade 00:24:09.076 --> 00:24:13.666 align:middle and don't really give them any option but to concede in a sense. 00:24:13.666 --> 00:24:17.146 align:middle And that's where the focus has been so far from the Chinese side. 00:24:17.146 --> 00:24:22.126 align:middle Now, with respect to Trump, again this is interesting because you can cut it both ways. 00:24:22.496 --> 00:24:26.606 align:middle All of these headlines around Greenland, the Panama Canal, all of this stuff, 00:24:26.606 --> 00:24:31.836 align:middle if there is really some substance to this, and this is the direction that the U.S. wants 00:24:31.836 --> 00:24:37.446 align:middle to move in, then China will want to move to take over Taiwan in some capacity. 00:24:37.446 --> 00:24:39.536 align:middle >> I think the way you phrased it is quite right. 00:24:39.536 --> 00:24:43.186 align:middle I mean, who knows if this is really the direction that the United States wants to go, 00:24:43.186 --> 00:24:48.186 align:middle but I do think that whether policy makers in DC realize it or not, these kind of conversations 00:24:48.186 --> 00:24:51.366 align:middle that they're having out in the open, will make the rest of the world wonder the same thing. 00:24:51.366 --> 00:24:55.326 align:middle Well who am I supposed to be looking at from an expansionary perspective. 00:24:55.326 --> 00:24:58.396 align:middle It lends itself to too many troubling conversations 00:24:58.396 --> 00:25:00.756 align:middle that could be happening from a geopolitical perspective. 00:25:00.876 --> 00:25:02.936 align:middle But again, you're quite right, let's see how the year unfolds. 00:25:03.306 --> 00:25:04.726 align:middle Let me ask you one last question, 00:25:04.726 --> 00:25:08.036 align:middle it is something I think worth exploring a little bit, social instability. 00:25:08.276 --> 00:25:11.716 align:middle I was sent a chart recently from the China Descent Monitor, 00:25:11.766 --> 00:25:15.076 align:middle and it shows the number of incidents of social unrest. 00:25:15.306 --> 00:25:18.136 align:middle If you look at the most recent click, it's up significantly, right? 00:25:18.136 --> 00:25:22.846 align:middle Whether you want to look it up in '24 or '22, either way, incidents are up. 00:25:23.036 --> 00:25:27.636 align:middle I immediately think well, maybe this has something to do with high youth unemployment. 00:25:27.636 --> 00:25:30.136 align:middle I know that the government's not even reporting that number anymore. 00:25:30.136 --> 00:25:34.796 align:middle I heard from another China economists that the number is still near 50%. 00:25:34.956 --> 00:25:36.076 align:middle Where is this coming from? 00:25:36.166 --> 00:25:38.516 align:middle And this unrest, is it something new? 00:25:38.516 --> 00:25:40.876 align:middle Has it been simmering for so many years? 00:25:41.076 --> 00:25:41.996 align:middle Give us your take on that. 00:25:43.056 --> 00:25:46.066 align:middle >> When they stopped reporting youth unemployment, 00:25:46.176 --> 00:25:50.306 align:middle if memory serves me right, that number was around 20%. 00:25:50.306 --> 00:25:56.036 align:middle And it is completely conceivable that our number has deteriorated even further. 00:25:56.266 --> 00:26:00.326 align:middle Now, I think that's a big component, but then there's other things the way 00:26:00.326 --> 00:26:04.136 align:middle that they handled COVID, the way that they're handling the property sector. 00:26:04.136 --> 00:26:05.586 align:middle So there's a lot of dissolution. 00:26:05.586 --> 00:26:10.066 align:middle But I think Beijing understands this and to that end what we're starting 00:26:10.066 --> 00:26:12.976 align:middle to see is the social support programs. 00:26:13.086 --> 00:26:18.416 align:middle So one thing that was in the news a couple of weeks ago was China will be ramping up support 00:26:18.416 --> 00:26:21.316 align:middle for graduate transition programs in a sense. 00:26:21.316 --> 00:26:24.906 align:middle So people coming out of university struggling to find jobs, 00:26:24.906 --> 00:26:28.116 align:middle they're looking to build in support programs for them. 00:26:28.356 --> 00:26:30.766 align:middle So yeah, it is an issue, and I think when you look 00:26:30.766 --> 00:26:34.016 align:middle at that chart you want to trace it back to COVID. 00:26:34.266 --> 00:26:39.866 align:middle From that period on we are seeing a noticeable uptick in these incident, 00:26:39.866 --> 00:26:44.326 align:middle and as much as Beijing would like these not to be reported 00:26:44.326 --> 00:26:46.616 align:middle in a sense, but yeah, it is an issue. 00:26:46.616 --> 00:26:49.116 align:middle But the main reasons why youth unemployment, 00:26:49.116 --> 00:26:51.906 align:middle there's just a skills mismatch in China at the moment. 00:26:52.106 --> 00:26:56.266 align:middle Private sector confidence, private sector investment, it's just not taking off 00:26:56.266 --> 00:26:58.596 align:middle and so job creation is a big issue. 00:26:59.416 --> 00:27:00.976 align:middle >> Well Shekabe, this was great. 00:27:00.976 --> 00:27:01.816 align:middle I loved all of this. 00:27:01.816 --> 00:27:03.906 align:middle This conversation was absolutely fantastic. 00:27:03.906 --> 00:27:06.406 align:middle I fear for you that we're going to have to do this again, 00:27:06.406 --> 00:27:09.376 align:middle because I think that between the U.S. and China we're both going 00:27:09.376 --> 00:27:11.086 align:middle to be very, very, busy this year. 00:27:11.086 --> 00:27:14.296 align:middle And so it'll be great to catch up with you in the next handful of months. 00:27:14.656 --> 00:27:15.386 align:middle >> Yeah, thanks Tom. 00:27:15.386 --> 00:27:18.116 align:middle This has been a great exchange, I loved every minute of it. 00:27:18.186 --> 00:27:23.286 align:middle Before I go I just want to wish everyone a happy lunar new year, so happy new year, 00:27:23.286 --> 00:27:29.206 align:middle [foreign language], and wishing everyone luck and prosperity, [foreign language]. 00:27:29.846 --> 00:27:31.096 align:middle >> Thank you, great way to end this. 00:27:31.566 --> 00:27:34.956 align:middle Thank you to the audience for listening, totally appreciate it as always, 00:27:35.006 --> 00:27:37.416 align:middle and look out for new episodes to come. 00:27:38.706 --> 00:27:40.406 align:middle >> We hope you enjoyed today's podcast. 00:27:40.406 --> 00:27:43.626 align:middle Subscribe to keep up with the latest episodes of All the Credit. 00:27:43.626 --> 00:27:48.326 align:middle For more insights and thought leadership, visit pgimfixedincome.com. 00:27:48.326 --> 00:27:50.766 align:middle This podcast is intended solely for professional investor use. 00:27:50.906 --> 00:27:53.176 align:middle Past performance is not a guarantee of future results. 00:27:53.256 --> 00:27:56.166 align:middle All investments involve risk, including the loss of capital. 00:27:56.166 --> 00:27:59.776 align:middle This material is not for distribution to any recipient 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