Is China’s Strength For Real?

With the Chinese GDP set to be released later this week, I decided to take a look at other recent data and dig a little deeper. Unfortunately, it seems that recent reports have been big on headlines but rather shallow in terms of actual production…

Is inflation really that hot?

Late last month, the consumer price index showed that inflation rose to 3.6% in March, up from the 3.2% we saw in February. Normally, when inflation is on the rise but under control, it’s a sign that the economy is doing well, as demand and spending pushes prices higher.

However, it appears that the recent rise in inflation wasn’t driven by demand at all. Rather, it was due to a spike in food prices. More specifically, it was driven by a sharp increase in vegetable prices, as a harsh winter took its toll on overall supply.

Chinese officials are hoping that inflation remains below 4% for the remainder of the year. The significance of keeping inflation low is that it gives the Chinese government more room to inject additional liquidity measures into the economy if it is needed.

Yes, we saw a trade surplus in March but…

Earlier this week, China released its trade balance report and the results were actually quite surprising. According to the trade report, China posted a trade surplus of $5.3 billion, after it was anticipated to print a deficit of $2.1 billion. This was also a nice bounce back from February’s figure, which showed a deficit of $31 billion.

The big elephant in the room though was that import growth was a mere 5.3%, way below the 9% forecast, indicating weak domestic demand. More concerning was that orders for metals and other industrial metals dropped, as companies adjusted to falling global demand.

So while the trade report was a pleasant surprise, the underlying numbers are actually quite disturbing, as they indicate weakness on both a local and global scale.

What are the Chinese PMIs not telling us?

Based on the Chinese manufacturing PMI printed last week, the industry expanded in March as the index climbed from 51 to 53.1 during the month. However, Chinese economic officials attributed this increase to seasonal factors, citing that the PMI typically rises right after the Chinese New Year.

Instead, HSBC’s version of the manufacturing PMI might be a more accurate measure of industry activity during this period. If you recall, the HSBC flash manufacturing PMI showed a drop from 49.6 to 48.3 in March, reflecting the steepest contraction in manufacturing activity since November last year.

And now for the million-dollar question…

What do all these mean for the markets?

At first glance, the stronger-than-expected figures from China led most market participants to believe that the People’s Bank of China (PBoC) will no longer need to loosen monetary policy any further. However, as our digging deeper into the numbers revealed, there are still plenty of weak spots in the Chinese economy that could use some stimulus from the Chinese central bank.

Aside from that, these signs of a gradual slowdown in the Chinese economy could continue to weigh on the Australian dollar. As I’ve mentioned before, China is Australia’s number one trading partner, which means that a decline in China’s domestic demand could eventually hurt Australia’s exports. And with Australia relying heavily on its commodity sales, a considerable drop in exports could hurt Australia’s overall economic growth and consequently the Aussie.

Unless the PBoC heeds the call for further rate cuts, China might not be in for as soft a landing as everyone expects. A sharp downturn in the Asian giant’s economy could bite a huge chunk off global economic growth, and this scenario could be negative for risk sentiment. Make sure you keep an eye out for the upcoming Chinese GDP data for the first quarter of the year to see whether China’s strength is for real or not!

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