China’s Economic Woes Bring Silver Lining for Global Investors

China’s lapse into deflation is fueling jitters across financial markets but money managers say it isn’t necessarily a bad thing.

(Bloomberg) — China’s lapse into deflation is fueling jitters across financial markets but money managers say it isn’t necessarily a bad thing.

Falling prices in the world’s second-largest economy are likely to translate into lower costs across the globe given China’s status as the factory of the world, according to EdenTree Investment Management and Gama Asset Management SA. Easing inflation will allow central banks to refrain from further interest-rate hikes, and possibly pivot to an easing, to shore up slowing growth.

The prospect of slower global price pressures may be one of the few upsides of China’s descent into deflation as the economy struggles to regain its footing after a post-Covid bounce faded. Inflation is likely to remain muted as a property slump and troubles in the shadow banking industry curb spending and investments by both consumers and companies.

“A weak China might bring forward the peak in monetary tightening,” said Christopher Hiorns, portfolio manager at EdenTree Investment. “It would also reduce demand for commodities which would reduce inflation pressures and may allow Western economies to run ‘hotter.’”

Inflation in the US and other countries has quickened in the years after the pandemic, cutting consumers’ purchasing power and forcing central banks to jack up interest rates. China’s predicament is different, owing to a variety of circumstances including a prolonged property slump that has hurt confidence and dented spending. The price of Chinese goods at US docks has dropped every month in 2023.

Read: Why Deflation Could Become a Welcomed Chinese Export: Next China

“The positive angle is that China’s slight deflation and slow growth will dampen inflation in the rest of the world even faster,” said Rajeev De Mello, a global macro portfolio manager at Gama Asset Management. However, a slowing China will also lead to a slowdown in Asia and Europe, he added. 

De Mello told Bloomberg Television on Tuesday that China’s export of deflation is positive for global bondholders and emerging-market assets.

To be sure, the impact of Chinese deflation on the world’s largest consumer, the US, and other trading partners may be minor and transitory. The US’ purchases of China goods has decreased, and the war in Ukraine is driving up the price of commodities such oil.

What Bloomberg economists say: 

On the current trajectory, a cushioned decline in China’s growth will have limited impact on the US economy or the Federal Reserve’s calculus. In a downside scenario, where China under-delivers on stimulus and growth spirals down, a shift to risk-off sentiment and tighter global credit conditions could tip the Fed into rate cuts sooner than expected.

Read more here.

In addition, any further stimulus from Chinese authorities may help arrest the economic downturn and put a floor under prices. The People’s Bank of China unexpectedly reduced a key interest rate by the most since 2020 on Tuesday, reflecting the growing concern about the worsening outlook. 

“The weakness of the Chinese economy and the apparent deflation are a clear dampener of global inflation,” said Gary Dugan, chief investment officer at Dalma Capital Management Ltd. “However, we don’t believe the Chinese authorities will sit back and just accept the current malaise.”

–With assistance from James Mayger and Marcus Wong.

(Adds Bloomberg economist comment)

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