East Asia Econ

Today's industrial price data for the first 10 days of September and property prices for August show intensified deflationary pressure. Yesterday's monetary data were weak. The PBC said yesterday that it will focus on price stability, but it also said it has plenty of other things to do as well.

More than 12M ago, we argued yields should fall. In that respect, today's drop to record lows isn't a surprise. We don't see anything fundamental yet to cause a change in direction. That's based on four factors: the PBC's reaction function, inflation, household savings, and the CNY.

It seems increasingly unlikely that exports can offset the weakness of domestic demand. Today's export data for August weren't strong. Volumes might be better, but the regional export cycle is likely peaking, and that at a time when China's domestic demand seems to be weakening further.

MoM core CPI fell again in August, and while perhaps a bit too early to pronounce that China is definitively in core deflation, it is getting close. PPI deflation also worsened, and the leads suggest that will continue. Despite stronger food prices, it is likely interest rates continue to fall.

Rather than thinking a weaker USD will be a catalyst for a stronger Chinese cycle, we worry more that a stronger CNY means even more downside risk, being another reason to conclude that the muddle through of the last 18M is running out of road.

The PMI for mfg fell further in August, and while for non-mfg it ticked up, the details across the surveys were soft. The drops in input prices and jobs were particularly noticeable. Maybe the Caixin PMI sends a different message, but today's data show a cycle that is starting to deteriorate again.

Yesterday, officials claimed high-tech industry contributed 60% of the aggregate rise in industrial earnings through July. That's partly because profitability in heavy industry is so poor. Even then, overall profits still only rose 4%. New sectors still aren't strong enough to really lift the whole.

Just as inflation concerns ease elsewhere, there's an acceleration in China. Food prices have risen 7% YoY in August, the biggest rise in more than 2 years. However, while that complicates the deflation narrative, it isn't enough to change it, given a renewed fallback in PPI and weak M1.

A chart-heavy note looking at some of the broader trends in China's foreign trade. Exports have been reasonably strong, but no more robust than they were before covid. The bigger change is in imports, which are weak, a trend that protectionism elsewhere will do nothing to resolve.

Rather than industrial policy, the better explanation for weak corporate finances is deficient domestic demand. Related to that, the biggest shifts since covid haven't been in export growth or PPI, but in imports and core CPI. Macro policy doesn't suggest this weakness is set to change.

We can't see anything in today's data to shift market sentiment. Property remains in a deep slump, and retail sales are weak. But that's not new, and with some of the pressure coming off the CNY, Beijing will probably think its muddle through approach of incremental easing will continue to work.

Today's property prices were very weak again, and that is important. But in the real economy, the deflator might still turn positive this quarter, because of the recent stabilisation of PPI, and the weather- and pork-propelled rise in food prices.

The PBC's Q2 survey shows consumption not especially weak, with the real post-20 changes in household behaviour being a shift from spending on goods to services, and from saving as property and riskier investments back to banks. The corporate survey wasn't bad either, but loan demand fell sharply.

The July price data offer more evidence that the food price cycle has turned. With less PPI deflation too, it is likely that headline CPI gets a bit of a lift. But core CPI inflation in July was once again very weak, which is enough of a reason to assume that the PBC will continue to cut rates.

July exports fell, but it is premature to call the start of a downturn. That's partly because of market share gains. These are solid, though not impressive enough to validate over-capacity. In terms of structure, the much bigger shift is in imports, which have completely over-turned pre-20 trends.

Our China cycle framework is that the muddle through of the last 18M is running out of road. The July PMIs look consistent with that, with weakness in pricing, jobs and confidence. The one remaining contrary indicator is the S&P mfg PMI, which has been strong, and for July will be released tomorrow.

A reminder of our roadmap for China's cycle over the next few months, which we summarised in an opinion piece in today's Nikkei Asia.

This is our monthly slide pack for China, that goes through the argument we laid out last week: how the Plenum and the US election together likely end the macro muddle through of the last 18 months.

Today's GDP release shows property activity is still collapsing and economy-wide pricing is weak. The PBC will struggle to hold up rates – and thereby the currency – if this week's Plenum doesn't provide a real boost to sentiment.

Even allowing for a change in credit intensity, June headline credit and money data are bearish. The one positive trend is data through May showing household demand deposits no longer falling so quickly. That shift continuing would help sustain China's macro muddle through.

We don't have conviction about what the Plenum will deliver, but we are confident that with next week's meeting, and then the US election, the macro and market muddle through of the last 18M is likely ending.

PPI deflation has been more cyclical than structural, and the strengthening in Q2 should continue into Q3. But core CPI remains very weak. Inflation is too low to support rates.

We combine quarterly household survey data with recently released annual GDP data to show why consumption isn't weak, what that means, and what there still is to worry about.