Chinese economic policy uncertainty set to rise

Every five years members of the Chinese Communist Party meet for its Party Congress. The event is typically where the ruling party shuffles leadership and addresses economic reform. Previous meetings have coincided with important announcements on investment in infrastructure. Currently scheduled for this October, the 19th such meeting may also be an important marker board for commodity markets.

Over the past couple years officials have embarked on a series of measures to try and cut production capacity across a range of industries including steel, coal and more recently aluminium. Cuts to domestic capacity have caused seaborne prices for these commodities and others related to them to soar as supply struggles to meet China’s infrastructure investment. One of the aims of these capacity slashing measures has been to improve environmental conditions, particularly those located in urban areas on the east coast that have had to contend with thick smog on a regular basis. However, more pertinent are Chinese authorities attention on financial stability and deleveraging as a critical objective.

Any backtrack on this focus may be a signal that markets may have got too far ahead of themselves. Look for any change in China’s commitment to a GDP target. There is a wide expectation that the Party will reiterate its commitment of doubling GDP by 2020 from the 2010 level, which requires the economy to grow at an average rate of 6.5 per cent in 2016-2020. Also important will be the level of support President Xi’s agenda. If his power is seen as weakened it may be interpreted as a negative for commodity markets and a sign increased volatility.

Previous Party Congress meetings have got some form in dashing expectations for higher prices. The chart below looks back at how copper prices performed before and after the past 5 Party Congress meetings. Copper prices typically rise in the twelve months preceding the meeting, and then peak 1-2 months before declining over the next twelve months to end below price levels seen 24 months earlier.

For sure, previous meetings have coincided with some tumultuous economic events. In 1997, just a few months before the Party Congress, the Asian Financial Crisis was just getting started with Thailand abandoning its currency peg against the US dollar. A series of currency devaluations by other countries in the region caused stock market declines and sharp drops in economic activity. And then in 2007 the Global Financial Crisis got underway as troubles emerged at Bear Sterns and interbank lending markets froze. The knock-on impact on confidence caused copper prices to fall initially and although they later rebounded, further bad news on the scale of the crisis caused copper prices to drop several months after the CCP. Nevertheless, both 1992 and 2012 exhibit the same trend even though China’s importance to overall copper demand radically changed during the intervening 20 years.

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