The Surprising Death Of Deflation In China

| About: iShares China (FXI)


PPI data has surprised to the upside almost consistently in 2016.

Chinese PPI has transitioned from "deflation" to "inflation".

A key driver of the turnaround has been the reflation of the property bubble, and a key beneficiary of this will likely be emerging markets, if historical patterns hold.

Is deflation dead in China? Well, for now the answer is "Yes" - China is now experiencing (Producer Price Index) PPI inflation after going through over 4 years of PPI deflation. The September reading was +0.1% YoY (versus expectations of -0.4% and the previous reading of -0.8%). There's a couple of really important charts on China and its PPI I wanted to show updates of below, so this article will mostly let the charts do the talking.

1. The surprising thing

The surprising thing about the turnaround in Chinese PPI from deflation to inflation is the fact that it has taken most by surprise. The monthly readings of PPI have almost consistently exceeded expectations, and by order of magnitude of around 30bps. This goes to show that people have been too negative and pessimistic on China and probably remain so - that creates the room for upside surprise.

2. Why did PPI turn around?

While you can point to a number of possible culprits for the turnaround in Chinese producers prices, such as the rebound in commodity prices and the weakening of the Chinese yuan (both of which are very important), another key driver - as the graph below shows - is the boom in property prices in China. The conscious reflating of the property bubble in China (interest rate cuts, mortgage rule easing, sales tax cuts, removal of purchase restrictions, hukou registration easing) has seen property prices surge - and in the past, that has usually led to a rise in producer price inflation, as we are now seeing.

3. One reason why Chinese PPI matters

While there are a couple of other reasons why China's PPI is of interest, a key one for investors is the apparent relationship between Chinese PPI and emerging market equities. Emerging market equities tend to do well when China is seeing a rise in producer prices, so the improving trend in the country's PPI is one thing that could give the emerging market equity rally room to run.

Bottom line: China has seen a turnaround from PPI deflation to inflation, partly driven by the reflation of the property bubble; this should be supportive for emerging market equities.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.