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  • Emerging Markets Debt Daily

    China Deflation Risk Is Back

    Natalia Gurushina ,Economist, Emerging Markets Fixed Income
    January 10, 2019

    Concerns about “deflation risks” in China are growing after another downside surprise in both consumer and producer prices. The Turkish lira gets a boost from the new eurobond, but there is more uncertainty about the policy direction.

    “Deflation risk” was a prominent theme in morning conversations about China. Both consumer and producer prices surprised to the downside in December, with the former easing to 1.9% year-on-year and the latter collapsing to a mere 0.9% year-on-year (the lowest since late-2016 – see chart below). The producer price dynamics reignited concerns about corporate profitability, with widespread expectations about additional targeted measures to support the industrial sector. We agree that lower inflation opens up room for easing. The policy mix, however, is a different story. Specifically, the current weakness of China’s transmission mechanism questions the efficacy of monetary policy, including both the reserve requirements’ cuts and potential cuts of the benchmark rate. Another China-related headline that caught our attention this morning and which points to broader geopolitical shifts is a massive increase – from 5% to 15%! - in the share of Russia’s international reserves kept in the Chinese renminbi.

    The Turkish lira rallied on the news about the USD2B 10-year eurobond sale, but nagging concerns about the country’s policy direction continue to pile up. The push to provide more financing in the run up to the local elections is quite obvious, explaining the rush to issue the eurobond and transfer (earlier than initially scheduled) TRY37B from the central bank to the Turkish Treasury under the profit-sharing agreement. A plan to create a special loan facility for small businesses raises yet another fiscal red flag, as the government is expected to provide support in terms of interest rates on these loans.

    The latest inflation prints in the Czech Republic may give more hawkish ammunition to the central bank despite a slightly lower than expected headline number. Headline inflation stayed unchanged in December at 2.0% year-on-year. However, it looks like most core inflation components continued to creep up, with some estimates putting it at 2.6% year-on-year. I am currently attending a Central European conference and the Czech National Bank’s arguments sounded much more hawkish than I expected. This echoes yesterday’s comments by the central bank’s Governor Jiri Rusnok, who noted that it will tighten further, especially if the currency does not strengthen.


    Chart at a Glance

    China Consumer Price Index

    Source: Bloomberg LP


    PMI – Purchasing Managers’ Index: economic indicators derived from monthly surveys of private sector companies; ISM – Institute for Supply Management PMI: ISM releases an index based on more than 400 purchasing and supply managers surveys; both in the manufacturing and non-manufacturing industries; CPI – Consumer Price Index: an index of the variation in prices paid by typical consumers for retail goods and other items; PPI – Producer Price Index: a family of indexes that measures the average change in selling prices received by domestic producers of goods and services over time; PCE inflation – Personal Consumption Expenditures Price Index: one measure of U.S. inflation, tracking the change in prices of goods and services purchased by consumers throughout the economy; MSCI – Morgan Stanley Capital International: an American provider of equity, fixed income, hedge fund stock market indexes, and equity portfolio analysis tools; VIX – CBOE Volatility Index: an index created by the Chicago Board Options Exchange (CBOE), which shows the market's expectation of 30-day volatility. It is constructed using the implied volatilities on S&P 500 index options.; GBI-EM – JP Morgan’s Government Bond Index – Emerging Markets: comprehensive emerging market debt benchmarks that track local currency bonds issued by Emerging market governments.; EMBI – JP Morgan’s Emerging Market Bond Index: JP Morgan's index of dollar-denominated sovereign bonds issued by a selection of emerging market countries; EMBIG - JP Morgan’s Emerging Market Bond Index Global: tracks total returns for traded external debt instruments in emerging markets.

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