According to official stats released early on Tuesday, factory activity in China actually increased in March. This came as a surprise to markets, which were expecting a contraction. It is particularly notable because China is the world’s largest importer of crude and would likely be affected by disruptions caused by the war in the Middle East.
The results raise the question of just how resilient certain key economic centres are, and whether market concerns about the war’s impact might be a bit exaggerated. Of course, another important indicator for the Chinese economic situation is coming up: the RatingDog (formerly Caixin) Manufacturing and Services PMIs. Economists are expecting this measure to also remain in expansion in March.
Why China’s Outperformance Is Particularly Relevant to Forex
The Asian Giant is the largest consumer of Gulf-sourced crude, so it is vulnerable to higher prices. But it’s worth noting that it is also by far the largest buyer of Iranian petroleum, which has largely been able to transit the Strait of Hormuz without issue. The market’s knee-jerk reaction has been to price in a full closure of the Strait, but certain economies are still receiving significant amounts of supply, including China.
As the world’s largest commodity consumer, China’s economic resilience is important to commodity currencies. But, it’s also the main export destination for several other countries, including Japan and Germany. If China’s industrial activity grows, it means it will likely increase imports from these economies and support their respective currencies as well.
The Inflation Impact
The other issue is demand destruction. Economic theory holds that as prices rise, people will buy less, thereby slowing the economy. But it’s also possible that people pay more, resulting in inflation without an increase in economic activity. China is the leading world manufacturer, particularly of plastic-based products. Over 90% of plastic is made from refined petroleum, and is already seeing price increases.
A look at Chinese data shows that buying activity remains in place despite price pressures. This could mean higher inflation down the line, of course. But one reason currencies like the Euro, Pound, and NZD are underperforming is the concern that their economies will slow. However, if there is enough room within people’s finances to absorb higher prices (that is, inflation is not all that high), then the economy might not slow down. Which means those currencies could rebound even before the war over.
What the Market is Looking For
This week, key economic data from China will provide further insight into how the war is affecting global economies. On Wednesday, the March Manufacturing PMI from RatingDog is released, expected to cool to 51.6 from 52.1 previously. This measure incorporates a wider range of smaller, export-oriented companies. If it, too, is above expectations, it could provide more general relief to markets that the war in the Middle East won’t be as bad for the global economy as feared.
Then on Friday is the Chinese inflation figures, which would also include the effect of higher energy prices. The annual March CPI in China is forecast to fall to 1.1% from 1.3% in February, as the economy struggles to sustain organic growth. If China’s inflation is lower than anticipated, it could mean that the initial price impact from higher crude prices on global economies is less than feared, which could support commodity currencies as well as other major fuel importers like the Euro, Pound and Yen.