Analysts are turning their eyes to China’s economic situation as the August Consumer Price Index (CPI) comes out any day now. They are forecasting an annual decrease of 0.2%. This forecast represents a dramatic turnaround from last month’s flat CPI of 0%. Beijing is in a bind as its economic troubles are multiplying. The big question — how successful will its strategies be in combating deflation — will be played out in the coming days.
Market participants woke up this morning to the surprise news that PBoC has fixed the benchmark USD/CNY exchange rate at 7.1008. This is a small decrease from yesterday’s rate. This action is indicative of a wait and see approach, underpinned by rising apprehension about the Yuan’s relative strength against the US Dollar. Most analysts still anticipate the Yuan to continue to strengthen in the near future. Other political surprises, as they often occur, or on the upside price surprises may upset this trend.
China’s economy has pleasantly surprised on the downside lately. In fact, it was on pace to return a 5.3% GDP growth in the first half of the year. Consumption has come roaring back, accounting for most of the strong growth in the overall economy. It’s not just the positive momentum of increased exports spilled over to non-U.S. markets. With recent data indicating a painful industrial slowdown, it’s hard to not question whether this growth is sustainable. As of July, the year-on-year change is only 5.7%, down from 6.6% in the first half of the year.
Economic Indicators Reflect Growing Concerns
This predicted CPI decline isn’t the only indicator of China’s precarious economic state. Alternative measures paint an equally worrisome picture. Retail sales growth has suddenly slowed to just 3.7% in July. That’s down from more than 5% in the first half of the year, a sign that consumer confidence is eroding. On top of this, manufacturing investment shrank by 1.3% YOY, painting an even more grim picture for industrial sectors.
Christine Peltier of BNP Paribas wrote that the joint portents of these economic indicators do not bode well. She noted, “the battle against deflation is far from won,” highlighting that upcoming inflation figures will be critical for understanding the broader economic context.
Our government is facing extraordinary, historic, monumental challenges. It’s under pressure to start taking the kind of measures that’ll generate sustainable, domestic demand. “The success of this strategy will depend on the government’s ability to sustainably support domestic demand,” added Peltier in her analysis.
Currency Movements and Market Reactions
Despite this extremely negative economic context, the Chinese Yuan has truly been a weak currency compared to the US Dollar. This has led the USD/CNH pair to be on a strong downtrend since the beginning of the year. The two enjoyed a short-lived increase, hitting an April high of 7.4291. Recent trends indicate the opposite: the currency is undergoing an unprecedented stabilization.
At the close of the most recent trading session, USD/CNH was trading at 7.1134, lower by less than 0.1%. Key support levels are being closely watched by analysts. The following key support area comes in around 7.1000, a level that has previously served as a base for prices and recently coinciding with the daily downtrend line.
Additionally, USD/CNH’s 100-day simple moving average is at 7.1873 right now. Markets are now focused on China’s inflation data for August. Investors are understandably worried about how these developments will impact currency strength and the credibility of our economic policy.
Implications for Economic Policy
The upcoming CPI data is thus high-stakes as far as public and investor confidence in China’s economic policies goes. A recent consensus forecast expects them to drop by as much as 0.2%. Other local businesses including China International Capital Corp (CICC) see a much deeper decline, 0.4%. Such results would be a clear indication that current initiatives are inadequate to counter deflationary trends or to boost demand in the economy.
China’s inflation figures are due out on Tuesday. As the new yuan figure represents an attractive new kinetic paradigm, analysts caution that they’ll do more than serve as leading economic indicators—they’ll condition the credibility of Beijing’s future economic policy. How the government reacts to this data will send powerful signals to the market and determine where investment will flow in the future.