East Asia Econ

Does anti-involution produce macro turnaround when the September combination of stock market and local government bail-out failed? The markets are hopeful. I am more cautious, given China's macro problems are weak demand as well as strong supply. I'd be wrong if household savings behaviour shifts.

The government is increasingly focused on the supply-side issue of corporate involution as the driver of unwanted deflation and weak corporate earnings. However, the decline in profits has been led by heavy industry, showing the importance of the weakness of property and aggregate demand.

Markets have perked up on hopes that officials will tackle over-supply. But belated publication yesterday at 8pm (!) of the PBC's quarterly opinion surveys is a reminder that business involution isn't the only challenge. Household price, income and employment expectations all continue to fall.

Based on official data, tariffs have as yet to cause any real reversal in the surge of export volumes that's now been underway for two years. That's even though export prices have, for the first time since 2003, started to rise YoY. It isn't obvious that China is absorbing the cost of the tariffs.

Today's release of more details of Q2 GDP are interesting, if puzzling. GDP was held up by a larger contribution from investment, even though construction contracted for the first time since early 2022. The weakness of construction does, however, further the economy's steady shift towards services.

Two things stand out in today's big macro release. First, more signs of property bottoming. But there's no indication of a pick-up, which matters given the second takeaway: the weakness of nominal GDP. On my numbers, that grew just 2.4% QoQ annualised, with the fall in the deflator accelerating.

Property price deflation intensified in June, albeit only mildly. Leading indicators suggest there shouldn't be a new step-down, but only interest rates point to real upside – and interest rates stopped being a reliable lead for the property market some time ago.

Continuing recent trends, credit and money data were stronger in June. That helps put a floor under the cycle. The details were softer, with credit growth dependent on government borrowing and mortgage lending still slow. But there are some signs of an upturn in lending to the non-state sector.

There aren't signs – yet – of China's export juggernaut hitting a wall. The big fall in US exports eased in June, allowing overall exports to continue to creep up, reaching a new post-2022 high. Imports, meanwhile, continue to flat-line, so the trade surplus remains large.

I am away from my desk, so for now, just a few charts on the CPI/PPI release. Deflation is deepening, which for PPI is broad-based. Core CPI is more stable, but that's partly due to a rise in "other" prices. Headline CPI is lower on food prices, which have started dropping again.

Recent data show investment fell in 2024 to under 40% for the first time since 2008. On the flip side, consumption edged up, helped by a stabilisation of the savings ratio and a rise in welfare spending. But none of these changes are happening fast enough to boost the cycle.

At a headline level, the industrial PMIs were better in June, but the details were weak, and there was no improvement in the services PMI. The rise in the credit impulse is taking away some of the downside risk for the cycle, but there aren't indications that the cycle is about to really improve.

Profits fell 9% YoY in May, and are now close to 5% of GDP, a level that's only been breached twice in the last 15 years. The driver is more demand- than supply-side, in the sense that the upstream profits, hit by the property downturn, are weakest. But even in machinery, profits aren't rising.

Given regional history, China's transition to exporting more capital goods shouldn't be unexpected. More unusual is that 1) this transition hasn't been accompanied by slower overall export growth, and 2) has occurred at the same time as a sharp slowing of imports. Chart pack attached.

Overall trade trends – strong exports, weak imports, and a big trade surplus – remain in place. But the Trump tariffs are causing big shifts in the structure of exports. Direct shipments to the US have fallen 40% this year, and excluding the pandemic, haven't been this low since 2013.

CPI was surprisingly firm in May, with core continuing to show a reversal from the deflation of 2024. Overall, however, nominal indicators remain very weak. Leads for core have started to deteriorated again, and PPI deflation accelerated in May. The GDP deflator will be negative once again in Q2.

The manufacturing PMI did improve in May, lifted by a bounce in export orders. But there's no sign of a turnaround in the underlying economy, with the construction PMI weak, output prices softening, and business confidence remaining poor.

Official industrial earnings show profitability deteriorating again. A rebound would be first seen in rising prices and improving corporate sentiment, neither of which is yet visible. The weakness is concentrated in heavy industry, but profitability in downstream sectors is only flat-lining.

Headline YoY data are still benefiting from the Q4 pick-up, meaning another 5% growth quarter is likely. But sequentially, growth is slowing again, with no sign of any turnaround in construction that might put a sustainable floor under the overall economy.

After a clear improvement from September, property price deflation since December has settled at an annualised pace of around -1.5%. Sluggish mortgage lending isn't pointing to a further recovery from here. On these official data, average prices are now down 6% from the peak in 2021.

Today's monetary data continue to suggest that the economy has bottomed, but don't point to a big recovery. Non-state and mortgage lending have stopped deteriorating, but don't show signs of the sort of recovery that would lift economic activity.

After the deflation of much of 2024, core sequential inflation has now been positive for six months. But it is now still only +0.2% annualised, and doesn't look to be going higher. Indicators for PPI suggest even more deflation ahead, with the one exception being the decline in the USD.

The expected fall in exports to the US did happen in April, but that was offset by stronger shipments to ROW. I wouldn't expect that to continue, but it is worth noting that today's data showed an increase in imports of components, which would usually indicate stronger exports in the next 3M.

Export orders fell sharply in April, but the PMIs overall weren't so bad. One reason is a bottoming of the construction cycle. That, however, isn't improving, and with prices and the business outlook falling again, the economy still isn't on a stable footing to get through the tariff shock.