It All Begins And Ends With China: "Is The Global Reflation Cycle Ending?"

Last night, China released factory inflation numbers (i.e., PPI), which slowed for a fifth straight month in Mar. ’18… marking the slowest Y/Y growth rate since Oct. ’16 (Exhibit 1). Similarly, the Mar. ’18 consumer price index (“CPI”) retreated from the four-year high set in Feb. ’18 (Exhibit 1).

Interestingly, we note that the Mar. ‘18  +2.1% Y/Y growth in China’s PPI missed Consensus’ expectation of +2.6% Y/Y growth, while the Mar. ’18 +3.1% Y/Y growth in China’s PPI also missed Consensus’ forecast of +3.3% Y/Y growth.

WHAT’S DRIVING COMMODITY-PRICE DEFLATION IN CHINA? As we’ve argued before, and as noted in Exhibit 2 below, it appears the swift collapse in China’s credit impulse (i.e., a fancy way of saying China is issuing less debt as a % of GDP) is driving a correction in China’s commodity consumption. Why does this matter? Well,  in our view, steel price strength in 2017 was due to China’s steel exports falling 33.4Mmt, or the second largest decline ever, trailing only that seen in 2009 (Exhibit 5) – China produces roughly half of world’s steel, meaning when they export less, global prices rally. While the driver in 2009 was the global financial crisis (“GFC”), the driver in 2017 was a record credit stimulus in China (i.e., $4.9tn in new credit issued) driving domestic demand, and thus boosting domestic Chinese steel prices. So, in general, while in most years China’s steel prices lag the rest of the world, in 2017 they were much higher; this, in turn, pushed mills in China to ship more domestically vs. to other countries, and thus drove up global steel prices –given China was >50% of global steel production in 2017, this had a big impact on global steel prices. However, this dynamic is now in reverse (Exhibit 6), which we believe forebodes risk to global steel prices.

CONCLUSION. When analyzing China’s Mar. ’18 PPI internals, looking to see what drove such weakness in China’s factory inflation numbers (Exhibit 7), it becomes clear that price deflation across the raw material and basic industrial complex was among the key drivers. Consequently, given China’s PPI is an excellent leading indicator into how China’s industrial economy is fairing, and also considering China’s Mar. ’18 Caixin Manufacturing PMI missed Consensus’ estimate (i.e., 51.0 vs. Consensus’ 51.7), we believe the 2018 “China slowdown” meme is firmly intact (we remind our readers that China consumes the bulk of the worlds commodity-metal output). Consequently, while China’s Mar. ’18 excavator sales growth rate of +78.9% Y/Y got a lot of people excited this weekend (we received a number of inbound emails asking our opinion on this surprisingly strong number), China’s loader sales fell -50.3% Y/Y in Mar. ’18 (i.e., the weakest growth in any single month since 4Q15’s global growth scare) and China’s Mar. ’18 crane sales growth fell to -12.8% Y/Y, or the weakest rate of growth in 17 months.

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