It was a full week of economic news flow. We were waiting for two, main announcements which both concerned inflation. This update details and explains the news alongside the specific factors that have impacted the overall figures:
First, China’s inflation: July inflation fell -0.3% y/y (June: flat). It’s worth noting the print is actually better than the forecast -0.4% y/y. Still, it highlights how local spending and liquidity remains weak.
The country’s property woes deepened as another developer, Country Garden, was not able to meet its $22.5mn coupon payment on two, $-denominated bonds. This follows four high-profile developers signalling liquidity stress on the back of a continuing slump in home sales. Even State-backed developers are suffering - despite their having better access to cheaper funding and better prospects of government support.
Shop owners are having to come up with better deals to entice value-seeking consumers to buy! Whereas in the West there were a range of pandemic-assistance schemes, in China they had to fend for themselves. Most government support was aimed at manufacturers. Foot traffic has returned but spending per person has down. It comes down to sentiment and confidence.
The main driver is weak manufacturing. Input (producer price) inflation shrank -4.4% y/y (an improvement on June’s: (-5.4%) but still close to its worst levels since the Yuan crisis of 2016. The only benefit – entirely at China’s expense – is that by exporting deflation for the time being, it helps ease import inflationary pressures overseas. This won’t last and is a temporary mirage. The turnaround is usually quick.
Second, US Inflation: July headline inflation rose +0.2% m/m to 3.2% y/y while core inflation (excluding Food/energy) also rose +0.2% m/m to 4.7% y/y. Both prints were below expectations and ease pressure on the Fed of further rate hikes. Nearly all of the increase came from a +0.3% m/m rise in shelter (one-third of the inflation weighting) taking it to 7.7% y/y. Rents gained +0.4% m/m. Food prices climbed 0.2% m/m while energy gained 0.1% m/m despite a big surge in oil prices. Real wages gained +0.3% m/m to 1.1% y/y. Used vehicle prices fell -1.3% m/m, medical care services -0.4% m/m, airline fares -8.1% m/m. The problem for the Fed is that while this news is welcome, it’s not compelling enough to say the hiking cycle is definitively over. Bond markets are pricing in odds the Fed will pause come September:
Two main issues remain for the Fed. To have a lasting rally, there needs to be a bigger drop in service inflation – and this is being held back by the pace of rising rents! The second is wages – which remain lofty as companies hang on to the workers they have. Strip out shelter and the inflation story looks somewhat different:
Taking stock of the above? No pun – it really comes down to the inventory picture. A very useful Goldman Sachs article looked at the global inventory cycle which has always driven global manufacturing. The inventory buildup following the pandemic era boosted activity in 2022. Since then, destocking has been underway resulting in manufacturing weakness in the first half of 2023. It will likely continue into the second half of 2023 in Europe and China but the drag on activity will start fading in the first half of 2024. The chart below shows how inventory-to-GDP ratios have started converging to pre-pandemic levels:
The pace of this normalisation varies around the globe but has been fastest in the US. Not far behind are Australia and Canada. So too are China and France. Korea has some way to go but the pace of normalisation has stepped up (light green line). As I referenced last week, keep a close eye on manufacturing activity (PMI) data during the rest of the second half of 2023. As we get through destocking, the manufacturing sector will turn – and then China won’t be exporting deflation much longer!
It was another good week for global Money Market funds which saw $40.88bn of inflows in a week driven by a weak China economy.
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