China Inflation and What It Says About the Outlook for Commodities

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The media has been focusing more on traumatic stories from China, like the continuing saga of Evergrande. This has shifted some of the attention away from the underlying economic data.

It’s still uncertain how China will address the housing issue, but as time goes on, the more likely it is that it won’t cause a major economic catastrophe.

The underlying economic data of the world’s second-largest economy and the largest industrial base, however, will have an impact on many of its trade partners.

In particular, commodity nations are in focus during the recovery as investors start looking for assets with a higher ROI. Australia’s outperformance as of late has relied entirely on the historically high commodity prices. Additionally, emerging markets, from Chile to Indonesia, are adjusting their monetary policy in anticipation of Chinese commodity demand.

Where things are going

Just last night, the Chinese Minister for Industry instructed Chinese steel mills to cut back production starting in the middle of next month, and throughout the winter.

The decision comes on the back of thermal coal reaching a record high. Despite China releasing strategic reserves in an effort to curb rising commodity prices, they have still gone higher.

The big question is, why is there so much demand?

Given the sluggish global recovery (consumer demand is still below pre-pandemic levels), why are industries so desperate to get their hands on raw materials?

It’s not a demand problem

Commodity production is at multi-year highs, particularly in Australia. Nonetheless, production is not reaching consumers, due to supply bottlenecks.

As much as 8% of the global fleet of bulk carriers are currently waiting offshore for China to give permission to unload their cargoes. Chinese factories are desperately seeking raw materials, not because they aren’t being produced, but because they aren’t being delivered. This pushes up producer prices, while businesses struggle to pass the cost on to consumers.

In the short term, pressures on margins could weigh on stock valuations. But if conditions persist, a general undermining of global equity markets could be in store.

Particularly if it comes at a time when global central banks are looking to tighten policy. That’s why we want to pay close attention to the difference between China’s PPI and CPI data released tonight.

What we are looking for

Analysts expect Chinese annualized inflation to come in at 0.9%, a modest increase from 0.8% prior.

This is well below the PBOC’s target, and the market could interpret it as a sign that China’s domestic economy remains under pressure. However, the faster-moving indicator, monthly inflation could accelerate to 0.3% from 0.1% prior.

Lastly, analysts predict producer prices to indicate an increase in the supply problem, at an annualized rate of 10.5%, up from 9.5% in the prior measure.

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