China And Reflation

Chinese PPI inflation picked up further in September, accelerating to 6.9% (6.3% previous, and consensus). It forms part of a trend that we have seen in China towards higher generalized inflation. We’re also seeing PPI inflation accelerating in the less commodity driven sectors, so it’s not entirely a commodity story. Likewise, non-food CPI inflation has been running at a solid pace in recent months, and echoes the trends seen in PPI and property price inflation. The GDP deflator has also rebounded notably (next reading of this later this week), which makes for better nominal growth outcomes, and this ties into the next part of the discussion… i.e. the investment so-what.

The improvement in nominal GDP growth outcomes is good for corporate earnings, and this is one driver behind the improved earnings outlook across Chinese and emerging market corporations. Indeed, the second chart shows the relationship between Chinese PPI and emerging market equities. This apparent correlation makes sense for a few reasons: 1. it reflects Chinese economic stimulus, which is directly beneficial for Chinese stocks and indirectly beneficial to rest of EM through trade/confidence; 2. it reflects higher commodity prices which is beneficial for the commodity sensitive EM countries; 3. it often ties into broader global reflation trends, which again helps through the confidence & demand channels as well as investment flows.

So overall this trend toward higher inflation in China is likely to have a continued supportive impact on emerging market equities, and contribute to the overall global reflation theme. The ongoing stimulus efforts e.g. recent RRR cuts, MLF operations, credit growth, will likely mean this is sustained short-medium term, however the rolling over of property prices is a risk and concern.

The big picture for inflation in China: property prices, producer prices, and consumer prices.