the market-driver obsession that US inflation has now assumed in the debate as a coterie to the broader topic of the taper and its fluctuations, in fact, risks overshadowing the explosion of producer prices in China.
Against a modestly growing CPI (+1.0% year-on-year and +5.3% monthly annualised), the PPI flew to its highest since 2008 as a result of rising commodity prices and increasing tensions on the global supply chain, container costs in the lead. An annualised +9% and an annualised +9.7% on a monthly basis means that the already exorbitant Bloomberg consensus of +8.8% has been exceeded. And here’s the problem: given the Covid outbreaks in China that have already prompted all the investment banks to drastically revise downwards the Dragon’s GDP for the third quarter, what combination is likely to be generated by such a mix? Stagflation.
An apparently lunar concept for an economy like China, which is used to growth rates in the structural 6% area, but one that could definitely complicate the picture, especially for the Fed. In fact, if there is one certainty in the world, it is the one based on the quid pro quo between the two formal enemies, Beijing and Washington: the former guarantees credit impulse to the global system through the continuous injections of the PBoC, while the latter accepts in exchange to import Chinese deflation from super-production. In fact, using it as a pretext for low rates and perennial stimulus. Now, however, the dynamic has changed.
Xi Jinping has long since put the Chinese system on a credit diet, limiting his interventions to cuts in reserve requirements or short-term injections to plug defaults on onshore bonds. On the other hand, a couple of weeks ago the market began to anticipate an expansive return of the PBoC, which had already intervened to calm the tech sector’s falls for fear of contagion to bonds and currency. Moreover, the return of the Covid had reinforced this certainty, as any closures or further slowdowns in growth – already seen in June and July – could have prompted the authorities to embark on an albeit brief round of support.
But with a PPI almost in double digits, what can be done? On the one hand, it could all be solved by a rapid normalisation of the health care situation, which would chase away bad thoughts about the combination of galloping inflation and low growth. But on the other hand, such a sudden stop-and-go could unsettle both the markets and the Fed, which has to deal with the ongoing ping-pong over reflation expectations. The plunge in the price of crude oil, linked precisely to the new contagions in China, speaks volumes in terms of growth expectations. All this, after the Dragon’s oil imports had already slowed dramatically in July from the record highs of June 2020. In short, beware of looking too much at the finger of US inflation. It could eclipse the moon of China’s stagflation risk, potentially a global reset event. At the worst possible time.