2019: Trade war fallout: Deflation

Consensus said:

Bloomberg's survey of 40 economists in February showed positive PPI forecast to be an average of 0.4% throughout Q2. 

We said:

Amid all the current market optimism that the US-China trade war is finally heading in a more positive direction, we identify two important developments under President Trump’s signal policy initiative. The first and most important is that the initiative has created conditions for the revival of deflation, a result that will not be welcomed anywhere. The second is the emergence of an Asian trading bloc, which will have longer-term implications for investors in the region.

Facing existing tariffs and fearing possible new ones, Chinese firms will aggressively move to reorient spare capacities to production for domestic markets, likely modifying products to meet domestic market preferences and even manufacturing new ones. Parallel efforts will undoubtedly focus on increasing sales elsewhere other than to the US, i.e. other EMs, Japan and Europe. Domestic deflationary pressures are already evident in the slide last month of the PPI below the CPI for the first time since 2011, to 0.9% yoy from 2.7% in November. The CPI, meanwhile, eased to 1.9%, from 2.2%. The net result of these developments will be to increase deflationary pressures globally, beginning with China.

The return of deflation exported by China will undermine a slowing global economic recovery. We project that the PPI will dip to zero in the second quarter before recovering in H2/19 as the full impact of the stimulus measures plays out.

 

Outcome:

Our call of Chinese PPI turning negative was hugely off-consensus when we made it. Our timing, however, was not perfect as PPI turned negative in Q3 instead of Q2.

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