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The recent tumble in the price of copper has sparked concerns that this cyclically sensitive commodity is signaling an increase in deflationary risk for the world economy. The initial catalyst for the change in the pricing fortunes for copper is bound up with worries about an economic slowdown in China.

The 14% drop in the spot price this year through yesterday (March 12) is said to be closely linked with China's first domestic bond default. As Reuters explains, the event "has raised concerns about a possible unraveling of the many loan deals which have used copper as collateral."

Copper is considered by some as the tip of the deflationary iceberg for the world economy. The ever-wary Ambrose Evans-Pritchard at The Telegraph is especially concerned about the potential fallout for Europe, which is already struggling with weak growth and disinflation. He argues that the European Central Bank's reluctance to roll out a stronger dose of monetary stimulus leaves the Continent "at the mercy of deflation shock from China."

The European Central Bank is betting that this is downward lurch in prices is a temporary blip due to lower energy costs, insisting that inflation expectations remain "firmly anchored". The collapse of iron ore and copper prices over recent days - on China jitters - should puncture these illusions.

Europe is surely vulnerable, but for reasons that go well beyond falling copper prices. But every forest fire starts small and so it's crucial to monitor the potential for knock-on effects from weak copper prices and the deeper problem of a softer macro trend in China these days. Adding to concerns is the latest drop in oil prices, which is also being read as a reaction to disappointing economic news out of China. Indeed, weaker-than-expected industrial activity, investment, and consumer spending in the world's second-largest economy has inspired fears of a new round of macro headwinds generally.

"The fairly dramatic slowdown is unusual in Chinese economic history of the last decade," Dariusz Kowalczyk, senior economist and strategist at Credit Agricole CIB in Hong Kong, observes in a note to clients. The latest numbers on China's industrial output, retail sales and fixed-asset investment for January and February are "shockingly weak," he writes. "It points to a major deceleration of momentum in the beginning of 2014."

But not everyone is quite so grim. "I think a further gradual slowdown of the Chinese economy is more reflected in this data than a hard landing," says Christian Schulz, senior economist at Berenberg Bank. "We always have to remember that the Chinese government has huge new private savings in terms of savings rate, low inflation, sound public finances and huge foreign reserves which allows them to intervene as well. Worse come to worse, the government is in the best position to react."

As for the US economy, a number of recent reports have reflected an economic slowdown, although it's unclear if this is due to a harsh winter or something darker. Today's update on retail sales and initial jobless claims may offer some fresh clarity, for good or ill. Given the recent news from China, however, the crowd's willingness to tolerate soft economic news will be tested anew in the days ahead.

For the moment, the broad US macro trend has yet to betray a clear and conspicuous warning sign, as I've been discussing recently (see here and here, for instance). If and when the US trend suffers a clear setback, we'll see the smoking gun in the numbers. Stay tuned.

Source: Does Copper's Slide Signal A New Phase Of Deflation Risk?