Stagflation Shockwave: China Surprises With Unexpectedly Strong Inflation As GDP Shrinks

With banks slashing China GDP left and right, with Goldman becoming the latest bank to do so over the weekend when it cuts its Q3 real GDP forecast by 3.5% to 2.3% Q/Q  (vs. 5.8% previously), and its full year GDP forecast to 8.3% yoy (vs. 8.6% previously) as the bank has “begun to see softening in national aggregate data” following another miss in China trade data, whisper expectations were for a miss in last night’s Chinese CPI and PPI prints. Instead, the opposite happened with both came in hotter than expectations – with factory-fate inflation (PPI) matching the highest level since 2008 on soaring commodity prices – even as CPI dipped modestly on a Y/Y basis thanks to sliding food costs which however were offset by rising non-food prices.

Here are the key numbers:

CPI: +1.0% Y/Y and +5.3% M/M annualized in July, down from 1.1% Y/Y in June but hotter than Bloomberg consensus: +0.8% Y/Y

Food: -3.7% Y/Y in July vs. -1.7% Y/Y in June.
Non-food: +2.1% Y/Y in July vs. +1.7% Y/Y in June.

PPI: +9.0% Y/Y in July and +9.7% M/M annualized, more than the +8.8% Y/Y in June and hotter than Bloomberg consensus: +8.8% yoy;

Some more details via GS:

China’s headline CPI moderated to +1.0% yoy in July from +1.1% yoy in June, on a high base (headline CPI prices were up 6.6% mom s.a. ann in July 2020), as shown in Exhibit 2. In month-on-month terms, headline CPI prices rose by 5.3% (seasonally adjusted annualized rate) in July (vs. 1.8% mom s.a. ann in June).

In year-over-year terms, food inflation was down to -3.7% yoy in July from -1.7% yoy in June. Deflation in pork prices widened to -43.5% yoy in July from -36.5% yoy in June, although sequential decline moderated. Inflation in fresh vegetables fell to -4.0% yoy in July from +0.1% yoy in June primarily on a high base. In contrast, inflation in fresh fruits increased to 5.2% yoy in July (vs. 3.1% in June) with a sequential growth accelerated significantly.
Non-food CPI inflation rose to +2.1% yoy in July from +1.7% yoy in June. Fuel costs increased by 24.7% yoy in July, from +23.6% yoy in June. Core CPI inflation (headline CPI excluding food and energy) rose to +1.3% yoy in July (vs. +0.9% in June), with inflation in services up to +1.6% yoy in July (vs. 1.0% in June).

Year-over-year PPI inflation increased to 9.0% yoy in July from +8.8% yoy in June, largely on a higher sequential growth. In month-over-month terms, PPI increased 9.7% (seasonally adjusted annualized rate) in July (vs. 6.4% in June). PPI inflation in producer goods edged up to 12.0% yoy in July from 11.8% yoy in June, and PPI inflation in consumer goods was flat at +0.3% yoy in July. Among major sectors, in seasonally adjusted month-over-month terms, inflation in the petroleum industry increased the most, followed by coal mining and chemicals, while inflation in metal sectors decreased the most in July.

In its summary, Goldman said that headline CPI inflation is likely to stay modest year-over-year in the coming months. High frequency data suggest that the year-on-year decline in pork prices was flat in early August, and year-on-year inflation in fresh fruits and eggs fell. The bank also expects year-over-year PPI inflation to moderate in coming months, although it may remain elevated in the near term.

Even if Goldman is right and somehow China is spared further inflationary pressures from collapsing supply-chains, this is a rather ominous – and potentially stagflationary – assessment as sticky inflation in a time when China’s economic output is set to slide on escalating Delta risks is something Beijing will have to address head on.

As Bloomberg’s Kriti Gupta writes, “the question is how does it spill over into everything else” especially this morning with commodities tumbling on fresh concerns about China’s commodity demand as Chinese crude oil imports fell in July and were down sharply from the record levels of June 2020.

“Both (benchmark crude) contracts look vulnerable to more bad news on the virus front, focusing on mainland China,” OANDA  market analyst Jeffrey Halley said in a note. RBC analyst Gordon Ramsay agreed, writing that “concerns about potential global oil demand erosion have resurfaced with the acceleration of the Delta variant infection rate.”

Sure enough, crude prices have dropped below the $70 per barrel level, and yet the reaction in yields, the dollar and stocks seem muted. This, as Gupta notes, is the disconnect to watch, at least in today’s trading session as the correlation between yields and commodities has climbed on an intraday basis in the last month or so.

And one more warning from the Bloomberg strategist: If China’s data is setting the tone for Wednesday’s U.S. CPI report and inflation metrics due from around the world, it may turn out to be a grim week, and that’s without taking the Delta and Lambda variants into account.