Fading Risks of Global Deflation?
One of the disinflationary pressures that’s gripped the global economy for the past five years is abating.
China’s factory gate prices -- falling since the start of 2012 -- turned positive in September, squeaking out an increase of 0.1 percent from a year earlier. Given China’s status as factory to the world, that means prices of everything from T-shirts, televisions, tools and toys may follow -- or at least stop getting ever cheaper.
With global demand still tepid -- as demonstrated by weak export numbers from China Thursday -- it’s premature to call for a bout of Chinflation that’ll send consumer prices surging from Tokyo to Berlin.Yawen Chen and Sue-Lin Wong of Reuters also report, China producer prices rise for 1st time in nearly 5 years:
"As reassuring as it is to finally see producer prices in China rising again, it is far too early to sound the all clear," said Frederic Neumann, co-head of Asian economic research at HSBC Holdings Plc in Hong Kong. "The world hasn’t fully escaped its deflationary funk over the past several years."
Core consumer prices in Japan fell 0.5 percent in August from a year earlier, the fifth-straight decline, while in the euro area they’re barely positive. U.S. inflation has fallen short of the Federal Reserve’s 2 percent objective for four years.
Yet the return of price gains at China’s factories does remove one of the forces that had been exacerbating the world’s deflationary spell. The following chart underscores the link between China’s PPI and its export prices:
“The turn up in China PPI is indicative of receding deflation risks globally,” said Shane Oliver, Sydney-based head of investment strategy at AMP Capital Investors Ltd., which oversees about $121 billion. “It’s another sign that global deflation is fading.”
Producer prices for mining goods swung to a 2.1 percent increase, and manufactured goods also turned positive. Food prices climbed 0.3 percent and clothing increased 0.7 percent.
As well as altering the global price outlook, positive producer prices and an acceleration in consumer inflation may limit scope for more monetary stimulus in China.
"Underlying inflation momentum is picking up, which will limit the room for monetary policy easing for the time being," said Zhou Hao, an economist at Commerzbank AG in Singapore. At the current pace of gains, he expects PPI inflation to quicken to 1.5 percent in December.
China's producer prices unexpectedly rose in September for the first time in nearly five years thanks to higher commodity prices, welcome news for the government as it struggles to whittle down a growing mountain of corporate debt.Not surprisingly, on Friday morning, global stocks and the US dollar rebounded on Chinese and US data:
Official inflation data on Friday also showed a pick-up in consumer prices, helping to ease investors' concerns about the health of the world's second-largest economy after disappointing trade numbers on Thursday rattled global markets.
Corporate China sits on US$18 trillion in debt, equivalent to about 169% of gross domestic product (GDP), according to the most recent figures from the Bank for International Settlements. Most of it is held by state-owned companies.
"An uptick in inflation, if sustained, would be good news for China's ability to service its overhang of corporate debt," Bill Adams, senior international economist at PNC Financial Service Group, said in a note. "With low interest rates keeping debt service costs in check and producer prices rising, the outlook for Chinese industrial profits is improving."
The producer price index (PPI) rose 0.1% in September from a year earlier, the National Bureau of Statistics said.
While the gain was slight, it was the first time producer prices have expanded on an annual basis since January 2012, and came a bit earlier than the year-end time frame that some analysts had expected. Producer prices had edged up on month-on-month basis over the summer.
Analysts polled by Reuters had predicted a decline of just 0.3% on-year, after a drop of 0.8% in August.
China's factory prices have been falling since March 2012, and more than four years of producer price deflation have squeezed industrial companies' cash flow.
Profits at roughly a quarter of Chinese companies were too low in the first half of this year to cover their debt servicing obligations, as earnings languish and loan burdens increase, according to a recent Reuters analysis.
However, a construction boom, fuelled by a government infrastructure spending spree and a housing rally, have helped boost prices for building materials from steel to copper in recent months, while coal prices have jumped as the government tries to shut excess mining capacity.
Prices of ferrous metals, non-ferrous metals and coal mining together rose 4.1% on-year, a key factor in the PPI turning positive, the statistics bureau said.
The number of industries registering price increases also rose to 25, eight more than the previous month, indicating that a recovery in Chinese companies' pricing power was becoming more broad-based.
"Debt pressure will certainly be reduced," said Zhou Hao, analyst at Commerzbank AG in Singapore. But he cautioned that China's mounting debt is also a structural problem, and that higher prices for commodities such as coal and steel may be "speculative" in nature.
CONSUMER PRICES ALSO PICK UP
Consumer price inflation also quickened more than expected to 1.9% in September year-on-year, mainly due to higher food prices. Food prices were up 3.2% in September on-year, compared with 1.3% in August.
Analysts had expected the consumer price index (CPI) to rise 1.6% from 1.3% in August, a 10-month low.
"A rebound in CPI growth is largely due to seasonal factors, and the overall growth trend is quite stable. It also dismissed previous concerns of deflation risks," said Zhang Yongjun, analyst at the China International Centre For Economic & Technical Exchanges.
The end of deflation is likely to dash any lingering expectations of further cuts in Chinese interest rates or banks' reserve ratios, economists at ANZ said.
The odds of such moves by the People's Bank of China (PBoC) had already been seen as rapidly receding due to growing concerns in the government about rapidly rising debt levels and potential asset bubbles.
"However, we do not expect the PBoC to tighten liquidity soon either," ANZ said in a note. "The PBoC should be balancing the yuan exchange rate, deleveraging, and the concerns around a slowing economy."
Global stocks and the dollar rebounded on Friday from losses a day earlier, buoyed by a surprising rise in Chinese producer prices and strong U.S. economic data that bolstered expectations the Federal Reserve would raise interest rates in December.As you can tell, inflation trends in China matter a lot because if that country manages to escape its deflation spiral, it will be exporting inflation rather than disinflation or deflation to the rest of the world.
The dollar was on track for its largest weekly increase in more than three months, with rebounding U.S. retail sales and a broad rise in producer prices last month indicating the economy regained momentum in the third quarter after a lackluster first-half.
U.S. producer prices rose in September to record their biggest year-on-year rise since December 2014, while retail sales gained 0.6 percent after a 0.2 percent decline in August.
"Observers are increasingly confident that December will finally bring the long-awaited interest rate hike," said Dennis de Jong, managing director at UFX.com in Limassol, Cyprus.
The dollar index, which tracks the greenback against a basket of six major currencies, added 0.4 percent to 97.862 (DXY) and was up 1.3 percent for the week.
In China, September producer prices unexpectedly rose for the first time in nearly five years and consumer inflation also beat expectations, easing some concerns about the health of the world's second-biggest economy.
Disappointing Chinese trade data on Thursday had rattled investors and pushed global equity markets to three-month lows.
European shares tracked Asian markets higher and Wall Street jumped as better-than-expected results from JPMorgan and Citigroup lifted financial stocks.
Shares of JPMorgan (JPM), the biggest U.S. bank by assets, rose 0.77 percent after it beat forecasts for revenue and profit. Citigroup (C) rose 1.18 percent after earnings fell less than expected.
In Europe, the pan-regional FTSEurofirst 300 index rose 1.55 percent to 1,344.44, while MSCI's all-country world index of equity markets in 46 countries rose 0.77 percent.
The Dow Jones industrial average rose 141.07 points, or 0.78 percent, to 18,240.01. The S&P 500 gained 14.08 points, or 0.66 percent, to 2,146.63 and the Nasdaq Composite added 37.96 points, or 0.73 percent, to 5,251.29.
Oil slipped below $52 a barrel, giving up earlier gains, as abundant crude supplies outweighed tighter U.S. fuel inventories and plans by the Organization of the Petroleum Exporting Countries to cut output.
"The fundamental backdrop is still bearish," said Commerzbank analyst Carsten Fritsch. "Every increase is driven by speculation and optimism," rather than tighter supplies, he said.
Global benchmark Brent was down 23 cents at $51.80 a barrel. U.S. crude CLc1 slide 8 cents to $50.36 a barrel.
The gain in Chinese producer prices helped lift U.S. Treasury yields, with the benchmark 10-year note down 8/32 in price to yield 1.7659 percent.
Rising U.S. Treasury yields, on the growing perception the U.S. Federal Reserve will raise interest rates in December, pushed euro zone government bond yields higher.
The benchmark 10-year German bund rose 2.1 basis points to 0.056 percent.
The dollar rose 0.63 percent to 104.31, while the euro fell 0.45 percent to $1.1006.
Also, as discussed in the articles, a pickup in inflation will dash any expectations of a rate cut from the People's Bank of China (PBoC) and help ease the Fed's concerns of global deflation, pretty much cementing a rate hike in December.
But while a pickup in China's inflation is welcome news, I remain highly skeptical that global deflation risks are abating, and judging by the market's reaction midday, traders don't buy it either as they sold the news (click on image):
Now, it's entirely possible the stock market ends up at the close on Friday but one thing I want to point out is the rally in the US dollar is worth paying attention to.
You will recall I openly questioned Morgan Stanley's call that the greenback was set to tumble at the beginning of August (they blew that call).
I've always maintained that global macro traders should short currencies where deflation is prevalent (like Europe and Japan) and go long currencies where deflation has yet to strike (like the United States). I also warned my readers to keep an eye on the surging yen as it could trigger a crisis, especially another Asian financial crisis.
The way to think about currency moves is simple. A rising currency lowers import prices and exacerbates disinflation and/ or deflation. In a country like Japan which imports and exports a lot of goods, a rising currency will wreak havoc on its exports and attempts to reflate inflation expectations. And more deflation in Japan puts more pressure on other Asian economies to lower prices, exporting deflation to the rest of the world.
This is why it's a big deal if China can escape deflation. The thing you need to ask yourself is whether the pickup in inflation in China is sustainable and credible or doomed to dissipate quickly depending on what is going on in Japan and the Eurozone. Because if Japan and the Eurozone can't escape deflation, it's hard to envision China escaping deflation (there is a reason why China's exports were down sharply, and it has to do with weak demand from Europe and elsewhere).
And if the US dollar keeps rising, and global deflation comes back with a vengeance, it's going to be hard for the US to escape deflation too.
One thing I can guarantee you, if the US dollar keeps rising, the Fed will proceed very gradually in terms of rate hikes. It might hike rates 25 basis points in December (not convinced it will) and wait to see the effects on emerging markets and China.
A rising US dollar will also effectively cap commodity prices (lower oil, gold, energy prices) and even long bond yields (lower import prices mean lower inflation expectations going forward). It will also alleviate pressure on the Fed to raise rates as a rising dollar tightens financial conditions.
As far as stocks, my thinking has not changed one bit since last week when I discussed whether you need to brace for a violent shift in markets:
[...] I still think we're headed for a long period of debt deflation but there are always going to be tradeable opportunities in these markets if you know where to plunge (and which sectors to steer clear of).One thing I will mention, however, is that since writing that comment last Friday, the biotech sector sold off sharply mostly on irrational fears of a Hillary Clinton victory and Democratic sweep in Congress, but also because of bad news from companies like Illumina (ILMN) which represents 4.3% of the Nasdaq Biotechnology ETF (IBB).
This brings me to the BAML report at the top of this comment. I remain highly skeptical of a global economic recovery and would take profits or even short emerging market (EEM), Chinese (FXI), Metal & Mining (XME) and Energy (XLE) shares on any strength. And despite huge volatility, I remain long biotech shares (IBB and equally weighted XBI) and keep finding gems in this sector by examining closely the holdings of top biotech funds.
And in a deflationary, ZIRP & NIRP world, I still maintain nominal bonds (TLT), not gold, will remain the ultimate diversifier and Financials (XLF) will struggle for a long time if a debt deflation cycle hits the world (ultra low or negative rates for years aren't good for financials).
As far as Ultilities (XLU), REITs (IYR), Consumer Staples (XLP), and other dividend plays (DVY), they have gotten hit lately partly because of a backup in yields but mostly because they ran up too much as everyone chased yield (be careful, high dividend doesn't mean less risk!). Interestingly, however, high yield credit (HYG) continues to make new highs which bodes well for risk assets.
What else? The perception that rising rates are here to stay is impacting biotech shares because they are mostly speculative stocks and rising rates will increase borrowing costs and hurt mergers and acquisitions in this sector.
I've always maintained that biotech shares (IBB and equally weighted XBI) are very volatile and not for the faint of heart. Still, with every big biotech dip, there is new money coming into the sector and even though it's volatile, the secular uptrend if far from over, regardless of who is the next US president. These big biotech selloffs represent big buying opportunities but they can be vicious so don't rush to catch a falling knife.
If the volatility in biotech scares you, stay away or buy the healthcare sector (XLV) on big dips as there are some big biotech companies in that ETF, and a few of them are extremely cheap in terms of valuation (I trade the smaller speculative names which swing like crazy both ways).
That last bit on biotech was for a cheap broker buddy of mine who has never donated a dime to my blog but loves teasing me on my stock recommendations. Still, he reads my comments religiously and admits that my macro calls are usually right on the money.
So let me end with this macro call, even though the pickup in inflation in China is encouraging, I still don't buy that deflation is dead or that the end of the deflation supercycle is upon us. Now more than ever, retail and institutional investors better prepare for that deflation tsunami I warned of at the beginning of the year.
And while some fear the next recession will end capitalism as we know it, I take a more sanguine view and remind myself of what my father always tells me, "plus ça change, plus c'est la même chose."
Lastly, have a look at something interesting Theodore Economou, CIO at Lombard Odier, tweeted on traditional fixed income indices (click on image):
Theodore is one of the smartest and nicest people I've come across in the pension and investment industry, you should follow him on Twitter here.
Also, Janet Tavakoli of Tavakoli Structured Finance emailed me to tell me Amazon has chosen her book, Decisions: Life and Death on Wall Street, as part of their prime reading program, which means you can read the Kindle version of her book for free.
And Jacques Lussier, President and CEO of Ipsol Capital and author of Successful Investing Is a Process: Structuring Efficient Portfolios for Outperformance, emailed me to tell me his new book which he coauthored with Hugues Langlois, Rational Investing: The Subtleties of Asset Management, will be out in March 2017. You can read pre-order it and read about it here.
On that note, enjoy your weekend and please remember to kindly donate or subscribe to this blog on the right-hand side via PayPal options I've listed for retail and institutional investors (you need to view these on your desktop or tablet, not on your cell phone). And that goes for my cheap broker buddies who love razzing me on my stock market calls (it's so much easier to criticize someone's calls when they get the research for free and don't have to think and put their neck on the line).
Below, Louis Kuijs, head of Asia economics at Oxford Economics, makes sense of positive CPI figures out of China on the back of weak trade data figures. He's more optimistic than I am in terms of interpreting China's trade data.
Second, Rebecca Patterson, Bessemer Trust CIO, says she is neutral on equities but investors should still own stocks. Smart lady, listen to her common sense advice.
Also, Chris Raymond, Raymond James analyst, discusses how to trade the biotech sell-off amid election season. Earlier this week, "Fast Money" traders discussed the biotech bloodbath and why healthcare was the worst-performing sector this week.
Lastly, Helima Croft, managing director of global head of commodity strategy at RBC Capital Markets, discusses the relationship between China and oil prices. Listen to her comments.
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