Weak China PMI throws cold water on signs of recovery

The Chinese PMI for July out this morning was very weak. The flash Caixin manufacturing PMI (formerly HSBC PMI) fell to 48.2 (consensus 49.7) from 49.4 in June. This was the weakest level since March 2014.

New orders fell to 48.1 from 50.3 and new export orders fell even more to 46.6 (the lowest since August 2013) from 49.9 in June. The new orders-inventory balance dropped sharply as the index for stocks of finished goods increased from 48.6 to 50.2.

Overall, this was a very poor result that pours cold water on the slight improvement in data we’ve seen in the past couple of months. This is likely to prompt the government to step a bit harder on the gas and ease policy further.

There are signs that the housing market is responding to the policy stimulus, which is often a good leading indicator for the overall economy. But the deterioration in PMI will trigger concern that the slowdown is more entrenched than thought and that the export sector is starting to suffer from the significant real appreciation of the CNY over the past couple of years. In addition, it raises concern that China may be feeling a stronger headwind than expected from the recent equity market turmoil. It will be important to watch the data in the coming months to see if this was a blip or a symptom of a stronger drag from the cross currents facing the economy. Our baseline scenario is one of gradual improvement in H2, but this number puts downside risk on that forecast.

One caveat is that PMI actually often lags monthly momentum in industrial production (see bottom chart). Hence it cannot be ruled out that the weak July number simply reflects the weakness seen in production earlier this year. If that's the case, we should see a turn in PMI very soon. For now however the PMI will cast doubt over the tentative recovery in China.

The poor export orders may fuel speculation that China will weaken the currency. However, we don’t expect this. The eyes of the Chinese government are very much on joining the SDR later this year (the IMF finalises its review in November) and China does not want to be accused of currency manipulation heading into that decision. The IMF said yesterday that the yuan review is going well as reforms advance and that they won’t decide on CNY joining the SDR based on short-term market movements. This suggests that the recent efforts by China to stabilise the stock market are not weighing much on the IMF’s decision.