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Chinese Data Drop Confirms Confirms Inflation Concerns Valid

Last nights Chinese data drop confirmed the growth rate is high, and the Chinese's ability to contain inflation will be tested.  The leaks from Chinese insiders on the growth rate proved accurate, confirming a 10.3% GDP growth rate.  This rapid growth may have produced the seeds for self-destruction considering the inflationary consequences as reported in the CPI and the PPI. 

The y/y Chinese  CPI did come in better than expected up 4.6% instead of the projected 4.7%, and 5.1% a year ago.  The m/m increase in the CPI was up 3.3%, and is higher than the Bank of China's target rate for inflation.   The y/y PPI was plus 5.9%, higher than the expected 5.6%, but down a couple ticks from last month's 6.1% 

For 2010, the main driver of Chinese inflation has been food costs.  The authorities claim that food prices were up only 7.2% for the year, but there are skeptics who think the numbers are rigged, and the real food inflation rate is higher.  These higher food costs combined with more expensive housing are a recipe for urbane social unrest.

Already, there are whisper numbers that the January inflation numbers will exceed those from December, as global food costs are rising.  As reported by Bloomberg, a spokesman for Mizuho Securities said that the December inflation rate, probably 4.6% will increase to over 6% in January.  Like the European sovereign debt crises, Chinese inflationary pressure is not going to magically vanish.  

What changes Chinese authorities will employ to navigate an orderly slow down are so far, unknown.  Without pending changes, China seem may be headed for a period of runaway inflation.  The Shanghai Composite Index was 2.9% lower after the data release, down to the lowest level since Sept 30th.  This index declined 15% last year.

Guilt by association, while not acceptable as legal evidence, does play a part in currency pair analysis.  Should the Chinese economy contract, the bigger trading partners would be hurt.  Japan is the biggest trading partner with China, and Australia, the largest commodity supplier are both trading lower today, in part a reaction to the Chinese growth rate.

Next week the US Treasury is going to hold an auction, selling $99B notes, comprised of $35B 2 year, $35B 5 year and $29B year.  Bernanke and company have been a big buyers of these maturities in the 5 and 7 year maturities, so it will be interesting see how the foreign buyers respond.  Currently the market for US 5 year paper is 2.0%, less than 2.47% in Britain, and 2.3% in Germany, but a big premium to the 0.50% in Japan.  The November TIC report revealed increased foreign demand for US Treasuries, but will this continue?

The USD/JPY briefly revisited the 82 handle, and then lost ground to the USD retreating about 100 pips.  It looks like this pair might be weakening, possible to the 84 level.  Lets try to buy around 82.50, and risk a sell off of 75 to the 81.75 area.  Perhaps the Bank of Japan will be there to help the trade.