Asia open: China's CPI inflation spark vs deflation in the PPI pipeline

China sort of inflating 

The latest inflation data from China, released on Saturday, revealed that consumer price inflation surpassed expectations while producer price deflation intensified once more.

Annual consumer inflation climbed to 0.7%, marking its highest level in almost a year. This uptick suggests that the economy is undergoing a reflation process, and policymakers may be gaining ground in their efforts to combat deflationary pressures.

The producer price index declined by 2.7% year-on-year, surpassing expectations and marking the 17th consecutive month of annual price declines. This ongoing trend indicates persistent deflationary pressures in the pipeline, hinting at soft consumption demand.

Deflation remains a significant concern among investors regarding China's economic landscape. Another concern is the escalating trade tensions between the United States and China. On Friday, Bloomberg reported that Washington is considering imposing sanctions on several Chinese tech companies, adding to the geopolitical uncertainties surrounding the two nations.

Capital outflows from China have been a consistent trend for some time. However, analysts at the Institute of International Finance suggest this trend may be reversing. In February, China experienced its first equity inflow in six months, marking its most significant influx of capital in over a year. This shift in capital flows could indicate changing investor sentiment and potentially signal renewed confidence in China's markets.

The clamour for increased fiscal and monetary stimulus has once again intensified recently. While no one advocates for the massive stimulus measures seen during the Great Recession, the fiscal measures announced alongside the growth target reveal a relatively modest approach. The official budget deficit target of around 3.0% of GDP remains unchanged from last year, despite a slight increase in the special government bond issuance to CNY4.0 trillion from CNY3.9 trillion. However, authorities will likely need to implement more substantial measures in the coming months.

Beyond increased government spending, it is evident that the Chinese economy requires structural reforms to encourage citizens to spend rather than save. This necessitates implementing long-term solutions, including establishing a robust social safety net, a higher labour share of income, and improved retirement benefits. However, none of these changes are imminent in the near term, highlighting the challenges associated with implementing such reforms.

The global landscape at the Asian market opening on Monday appears to be a mixed bag. On one hand, indications suggest potential interest rate cuts in the U.S. and euro zone beginning in June. However, there are also indications that the impressive rally on Wall Street is losing momentum as investors turn to US inflation data.

Last week, the S&P 500 and Nasdaq closed lower. While this marked only the third weekly decline in 19 for both indices, it occurred despite a significant drop in Treasury yields, which is most unusual in a post-Covid investment world.

US CPI commentary

The previous month's CPI update was marred by a public relations incident at the BLS. In an unfortunate attempt to manage a deluge of inquiries regarding an exceptionally high reading on OER in the January release, a BLS staffer inadvertently Bcc'd inquisitive analysts on a group email, referring to them as "super users." This misstep created the perception of a privileged data recipient list.

The BLS provided a detailed explanation for the overshoot in OER, but some lingering questions remained unanswered. Assistant Commissioner Rob Cage summarized the situation by stating, in simpler terms, that there may be some volatility in the OER measure moving forward.

Whether the Fed will need to overlook this critical component of shelter inflation in 2024 remains uncertain. However, the Fed had been anticipating shelter disinflation; if this assumption proves incorrect for any reason — whether due to statistical fluctuations or the ongoing issue of housing unaffordability for many Americans — it will pose a communication challenge for Jerome Powell regarding the anticipated rate cuts.

In any case, Economists anticipate that core prices rose by 0.3% in February compared to January, which would represent a deceleration from the previous month's 0.4% pace, which had unsettled the markets.

Anyone with long indexes or recently shorted the US dollar doesn’t want a repeat of the last CPI release. Regardless of the malefactor, another report or two like January’s would cast considerable doubts on the merit of rate cuts in 2024.

Remembering that the political climate could impact the Fed's efforts to remain neutral is essential. The truth is that politics will likely influence the conversation surrounding any decisions made this year now that the two main political parties are established. The Fed may try to avoid politics, but politics will be paying close attention to the Fed.

The challenge with persistent inflation in the first half of the year is that it delays potential rate cuts until the second half, bringing them closer to the election cycle. While this timing might not significantly impact economic dynamics, implementing rate cuts in July or September wouldn’t result in an immediate ore election economic boost. However, the timing carries considerable weight in terms of public perception. Implementing rate cuts close to the election could invite accusations of political maneuvering and reinforce the belief that the entire US government is working against their preferred political figure, particularly among Trump's supporters. This perception could further exacerbate political divisions and heighten tensions during an already contentious election season.