What is going on in China??? - Oct 4

[dan_s]

Note received from Jefferies Equity Research this morning.

"Ironically, both the Western World and China are experiencing significant problems in delivering uninterrupted, affordable electricity. Global supply bottlenecks are fueling PPI pressures which will inevitably lead to China exporting higher inflation to the rest of the world."

A stagflation environment is emerging as the rationing of electricity comes alongside uncomfortably high producer prices. We repeat that there are material downside risks to China’s GDP for this year and next. The PBOC appears unwilling to ease policy. The impact of slower domestic growth as well as the curtailing of critical manufacturing items such as PCBs, packaging due to power shortages will hurt global trade. We examine the implications.

The two major economic blocs are moving in opposite directions in terms of monetary policy. The US is attempting to become more restrictive with the front and long end of the US yield curve shifting upwards. With US house prices increasing rapidly (~20% y-y, July) and job openings at a record high to the number of unemployed, the US economy is running hot. In contrast, China is slowing down well below trend as the authorities pursue a restructuring of the economy that will be focused on the consumer. This has brought a great deal of idiosyncratic risk from anti-trust measures on the private sector to spillover risks from the slowdown in real estate construction. However, the electricity supply shock has been caused by a succession of factors – a surging thermal coal price and a reluctance of the authorities to raise electricity prices due to inflation concerns, surging demand (+14% y-y Jan-Aug.21) as the economy has recovered post-pandemic and a tightness in generating capacity, Beijing’s environmental campaign to meet its long-term climate change commitment by imposing very restrictive carbon emission targets on local governments as well as the desire for ‘blue skies’ ahead of the Beijing winter Olympics in February, 2022.

With the winter season almost upon China, if the power crunch is extended into 2022, it will be stagflationary for the economy - as it will undermine output growth whilst pushing up price levels. In turn, this would increase the difficulty for Chinese policymakers to ease. The granular details of the Caixin China PMI (September 50 vs 49.2 previously) showed that firms indicated that relatively subdued demand and material shortages had weighed on production. But inflationary pressures picked up in September, with average input costs rising sharply overall.