If it wasn’t already, speculation about the outlook for the Chinese economy looks set to dominate markets in 2016.
A raft of uninspiring economic data, along with a continued and accelerating weakening in the Chinese yuan, rattled risk assets last week, intensifying fears that the world’s second-largest economy is slowing far quicker than what policymakers would want.
If there’s one thing that markets hate it’s uncertainty about what the future holds. Will China’s economy splutter through 2016, much like 2015, or will the slowdown become even more pronounced, leading to additional monetary policy easing, further weakening in the yuan and, as a consequence, slower global growth and continued disinflationary pressures?
In the wake of recent market ructions caused by fears over China, Zhiwei Zhang and Li Zeng, China economists at Deutsche Bank, have been busy tweaking their forecasts for Chinese economic growth, the year-end level of the USD/CNY and the probability of further monetary policy easing in the year ahead.
As the graphic below reveals, the pair’s baseline forecasts this year revolve around a continued slowdown in growth, a sharp depreciation in the value of the yuan and a series of rate cuts delivered by the PBOC.
Their favoured outcome for GDP is for the economy to expand by 6.5-7%, attaching a 50% probability that growth in this range will occur. Reflective of the growing view that risks to the growth outlook are tilted to the downside, they see a 30% risk that growth will fall to 6-6.4%.
While their view on growth is consistent with the range expected to be be announced by the government, they expect that the yuan will weaken significantly against the USD, revising up their year-end forecast from 6.7 to 7.0.
They attach a 50% probability that it depreciates by between 5-10% with a depreciation of more than 10% seen at 20%. Only 30% probability of no change, or a depreciation of between 0-5%, is seen.
On interest rates, Deutsche suggests two additional rate cuts is the most likely scenario, putting the odds at 50%. Indicating that risks for this forecast are slanted towards additional policy easing, they attach a 75% chance of two more rate cuts eventuating.
Here’s Zhang and Zeng’s view on what their forecasts mean on the outlook for the Chinese economy in the year ahead.
We see risks that China’s economy is tilted toward the downside. We assign 40% probability that growth may drop below 6.5% in 2016, which implies the government may miss the growth target.
We expect the risks will grow higher without a major change in policies. We expect the probability of sub-6% growth to rise beyond 2016. This is based on the assumption that the progress of structural reforms remains sluggish, and the government continues to resort to a credit-driven approach to boost growth.
We see risks to our policy outlook tilted toward more easing, both through interest rate cuts and through Renminbi depreciation. This is natural as our growth forecasts are tilted to the downside. We do not provide explicit probability forecasts to M2 and bank loans, but we also see higher probability for these policy variables to surprise on the loose side as well.
Inflation is not a major concern in 2016, which opens room for policy easing if necessary.
Not exactly what markets were looking for, weakening growth and a sharp devaluation in the renminbi. And while monetary policy easing formerly helped to boost market sentiment, given its limited impact on the economy in 2015, further rate cuts will likely act to amplify concerns that all is not well when it comes to China’s economic transition.
It’s hard to see where the upside risks will come from, and demonstrates why concerns remain elevated at present.
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