Chinese reflation is the new pandemic

Local market had a negative day on weak turnover. It started positive and then faded into the China inflation update. The fade turned into more of a slide lower after that. We are in the 12th consecutive week with aggregate weekly turnover below $40b. Mining and Utilities were the best of the green sectors while Staples and Property were the worst of the red sectors. Victorian covid cluster seems to be improving but spot fires are expected to remain as part of normal cycle.

Market has been trying to balance the inflationary pressures against the opening up recovery and stimulus. China data was always going to be key to the market sentiment. Chinese corporates have been in a down grade cycle on profits and cashflow. That is the main reason they moved on commodities. If the historical trend holds, commodities cycles linked to China starts when Producer Price Index (PPI) growth bottoms and ends when PPI peaks. China just delivered a 12 year peak cycle data point and China has been left with no option but to push down commodity prices. Chinese inflation is also rising but it has not become a problem yet. China has been able to boost the Yuan and control down some of the food prices and limit the damage to their consumers. But falling corporate profits and weak cashflows are not sustainable when the problem keeps getting worse. China needs the Yuan strength to deal with the inevitable geopolitical problem escalating with US. China will also make inflation to their consumers worse by devaluing the Yuan. The logical step for China in the current macro mix is to control commodity prices. History shows that has been their preferred path of control and it has worked before.

The main game is the reflation. Chinese PPI and strong Yuan will inevitably drive up global inflation as manufacturing giant. The question now the market is dealing with is…How hot is the US inflation update on Friday morning? Time will tell. Central Banks are playing chicken with inflation where they have a poor track record while markets are backing them. Endless stimulus and pandemic issues have let the reflation cycle out of the Pandora’s box. Historic high US market multiples will be tested during reporting season with rising costs due to commodities, wages and currency. US reporting seasons over the decades have gone from 50% beats to nearly 90% beats in recent cycles. Chinese corporate cycle may be the leading indicator of downgrades coming in the US corporate outlook statements in July. Transitory or not, stretched markets with downgrade risk is a dangerous mix.

Reuters on China data…

China’s factory gate prices rose at their fastest annual pace in over 12 years in May, driven by surging commodity prices, adding to global price pressures at a time when policymakers are trying to revitalise growth following the COVID-19-induced slump. Investors are increasingly worried that pandemic-driven stimulus measures could supercharge global inflation and force central banks to tighten policy, potentially curbing the recovery. China’s producer price index (PPI) increased 9.0% from a low base a year earlier, the National Bureau of Statistics (NBS) said in a statement, driven by significant price increases in crude oil, iron ore and non-ferrous metals. Analysts in a Reuters poll had expected the PPI to rise 8.5% after a 6.8% increase in April. Consumer prices saw their biggest year-on-year increase in eight months but came in below expectations and remained well below the government’s official 3% target. The surge in PPI has yet to feed through to consumer inflation, meaning the People’s Bank of China is unlikely to worry for now.

CNBC on geopolitics…

China’s manufacturers also face pressure from an expected drop in overseas purchases. A surge in exports, driven by global demand for face masks and other health-related goods, helped boost China’s economy last year during the height of the coronavirus pandemic. Businesses are absorbing costs for now and not cutting workers, Gan said. However, she said Chinese manufacturers expect foreign orders to decline slightly, even if overseas demand does ultimately stay about the same. “In general people are uncertain about what’s happening overseas,” she said. “One is Covid, the other is (the) trade war and overall sentiment against Chinese businesses.” Tensions between China and its largest trading partner, the U.S., have escalated in the last three years as both countries levied tariffs on goods from the other. Chinese exports to the U.S. grew in May from the prior month, but imports declined.

Let us run through the main data points released in the last 24 hours…

Consumer prices in Russia jumped 6.0% in May of 2021, following a 5.5% increase in the previous month and rose faster than market expectations of a 5.8% hike. The latest reading remained well above the central bank's 4% target and it was the highest inflation rate since October of 2016, mainly driven by prices of food (7.4%), non-food products (6.7%), and lastly, services (3.3%). On a monthly basis, consumer prices went up 0.7%, following a 0.6% advance in April and compared to forecasts of a 0.6% rise.

Japan's economy shrank at an annualized rate of 3.9% in the first quarter of 2021, compared with the preliminary figure of 5.1% contraction and market consensus of a 4.8% fall and following an 11.7% growth in Q4. Private consumption, which accounts for more than half of Japan’s GDP, fell 5.8%, the first drop in three quarters, after a 9% growth in the December quarter. Also, government spending decreased 4.5%, following a 7.3% advance. Meantime, business spending shrank 4.6%, after an 18.3% jump in the December quarter.

The Euro Area economy shrank 0.3% on quarter in the first three months of 2021, compared with a preliminary estimate of 0.6% contraction. Still, the bloc entered a double-dip recession as activity and demand were hit by fresh distancing and lockdown measures imposed during that period, to curb the spread of the coronavirus pandemic. A sharp decline in household consumption was partially offset by an increase in fixed investment and positive contributions from net trade and inventories. Among the bloc's largest economies, Germany, France, Spain and the Netherlands fell back into contraction territory, while Italy's economy posted modest growth despite the restrictions. Year-on-year, the GDP dropped 1.3% in the first quarter, much less than a second estimate of 1.8% fall.

The ZEW Indicator of Economic Sentiment for the Euro Area eased by 2.7 points to 81.3 in June of 2021, due to a reassessment of the economic situation, as it returned to pre-pandemic levels. In June, inflation expectations went up by 2.0 points to 79.6, with almost 84 percent of the surveyed analysts expecting higher inflation rates in the coming six months. Meanwhile, the indicator for the current economic situation in the Eurozone increased by 27.0 points to -24.4.

The NFIB Small Business Optimism Index in the United States stood at 99.6 in May 2021, slightly down from the previous month's five-month high and well below pre-pandemic levels. It was the first decline in morale this year, as small-business owners were concerned about labor shortages and growing inflationary pressure. A record 48% of small businesses surveyed could not fill open jobs, even with many of them offering higher pay; while higher inflation was making it harder for them to plan ahead.

Retail sales in Brazil grew at a record 23.8% year-on-year in April of 2021, above market estimates of a 19.8% jump, mainly due to a low base year effect linked to the beginning of the Covid-19 crisis. Year-to-date, retail sales advanced 4.7% compared to the same period a year ago.

The US trade gap narrowed to $68.9 billion in April of 2021 from a record high $75 billion gap in March and in line with market expectations. Exports were up 1.1% to $205 billion, due to civilian aircraft ($1.4 billion), crude oil ($1.0 billion), other petroleum products ($0.6 billion), fuel oil ($0.5 billion), travel ($0.2 billion) and transport ($0.2 billion). Imports dropped 1.4% to $273.9 billion due to other textile apparel and household goods ($-0.9 billion), toys, games, and sporting goods ($-0.7 billion), household appliances ($-0.7 billion), automotive parts and accessories ($-0.7 billion) and passenger cars ($-0.5 billion). The deficit with China decreased $7.1 billion to $32.4 billion as exports were up and imports declined.

South Korea’s GDP grew 1.7% on quarter in the three months to March of 2021, compared to a revised 1.1% expansion in the previous period and to a preliminary reading of 1.6%. Private consumption grew by 1.2% while government expenditure rose by 1.6%. Net trade contributed positively to growth, with exports surging by 2.0% while imports were up by 2.9%. On an annual basis, GDP expanded 1.9% after a revised 1.1% drop in the previous quarter.

The Westpac-Melbourne Institute Index of Consumer Sentiment fell by 5.2 % month-on-month to the lowest in five months of 107.2 in June 2021, amid concerns over a lockdown in Melbourne and some disappointment around the federal budget. The latest reading also reflected a statistical correction following a very strong surge in April to an eleven-year high. All components of the Index dropped, most moving back into line with their levels back in January: the family finances vs a year ago (-8.5% to 89.6), the family finances for the next 12 months (-2% to 107.3), economic conditions in the next 12 months (-10.3% to 108.7), economic conditions in the next five years (-1.4% to 114.0), and time to buy a major household item (-4.1% to 116.5). In addition, the unemployment expectation index jumped 8.2% to 108.4.

China's annual inflation rate jumped to 1.3% in May 2021 from 0.9% a month earlier and compared with market consensus of 1.6%. This was the highest reading since September 2020, amid a faster increase in cost of non-food goods (1.6% vs 1.3% in April), led by transportation & communication (5.5% vs 4.9%); clothing (0.4% vs 0.2%); rent, fuel & utilities (0.7% vs 0.4%); health (0.2% vs 0.1%), household goods and services (0.4% vs 0.4), and education, culture (1.5% vs 1.3%). Also, food prices went up 0.3%, the first rise in four months, after a 0.7% drop in April. On a monthly basis, consumer prices fell 0.2% in May, compared with forecasts of a 0.1% decline and after a 0.3% drop in April.

China's producer prices rose by 9.0% year-on-year in May 2021, accelerating from a 6.8% gain in the prior month and above market expectations of 8.5%. This was the fifth straight month of increase in factory gate prices and the steepest pace since September 2008, amid a faster recovery in domestic production and rising commodity prices. Prices of means of production went up much faster (12% vs 9.1% in April), boosted by extraction (36.4% vs 24.9%), raw materials (18.8% vs 15.2%), and processing (7.4% vs 5.4%). In addition, prices of consumer goods increased more (0.5% vs 0.3%), mainly led by both food productions (2.2% vs 1.8%) and daily use goods (0.5% vs 0.3%), while both clothing (-0.6% vs -0.6%) and consumer durables (-0.8% vs -0.9%) fell further. On a monthly basis, producer prices went up 1.6%.

Comments on US market last close…

US market was aimless again after starting positive. RUSSELL +1.06%, NASDAQ +0.31%, S&P +0.02% and DOW -0.09%. The big news overnight was the cloud platform Fastly going down and taking down major news, social media and government websites globally. If it wasn’t a hack, they just showed the hackers a great target. Opening up thematic remains and helped RUSSELL with vaccine rollout. Yields coming back helped NASDAQ. The market moves were weird today as most commodities were up with USD. Gold was up and down and finished a tick lower. VIX is back above 17. In the last 24 hours we have learnt that governments can trace crypto currencies and they can listen into encrypted messaging services. That does raise questions about those models. Energy and Property were the best green sectors while Utilities and Staples were the worst red sectors.

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