China teeters on the edge of deflation
There had been a line of thought that the grand reopening of China's economy could prove to be inflationary, adding fuel to the fire for the rest of the world and pushing interest rates higher for longer.
It hasn't worked out that way, however.
Annual inflation in China fell to zero per cent in May, and if recent trends in producer prices prove to be a useful guide, then we can expect deflation for China ahead.
Producer price inflation fell to a deeply negative -5.4 per cent over the year.
This is a fairly dramatic and surprising data release.
In the modern era inflation in China has only turned negative previously during COVID, the global financial crisis, and before that during the Asia crisis of the late 1990s (carrying through to the early 2000s tech bust).
Source: Goldman Sachs
China teetering at risk of recession might account for a recent modest decline in Aussie share prices to the lowest level since March - with miners wearing a fair chunk of the decline - but on the other hand it might also prove to bring renewed stimulus in China.
What's going on here?
What's the cause of this?
Overall it seems that a weak property market in China is a major driver of the stalled recovery, and this could well mean that interest rate cuts in China are in the post.
It also aligns with my general line of thinking that we're going to hit an inflection point soon where the narrative shifts from the risks of sustained inflation to the risks of the global economy slowing too much, tipping into a recession.
The US inflation figures for June are due out on Wednesday, and the median market consensus forecast if for inflation to drop to just 3.1 per cent over the year (while Canada has already seen its inflation rate drop to only 3.36 per cent for the year).
Given that the Federal Reserve has already hiked by 500 basis points as supply continues to ease, it doesn't seem out of the question that year-on-year inflation could even drop below target over the next year, and certainly so for goods prices.
The brilliant Charlie Bilello's graph below of used car prices is a useful illustration of why.
Although US car prices are still considerably higher than they were in early 2020, they are now -10 per cent lower over the year.
Australia similar, but lagging
Despite these global trends, Australia is some way further back in this journey having kept the borders and economy closed for longer, and the Aussie 3-year bond yield is still trading above the June 2022 highs, at 4.18 per cent.
There are at least some encouraging signs that we'll be following a similar trajectory for consumer prices.
It's clear that inflation in Australia peaked in late 2022, and some goods prices are showing promising signs.
Having absolutely rocketed through the pandemic stimulus the price of unleaded fuel has now pulled back from close to $2.20 to a more reasonable $1.75 per litre, for example.
There are still some areas where significant inflation is in evidence, though: energy prices and household bills, rents, and insurance premiums, for example.
Australia's quarterly inflation figures for the June quarter aren't due to be released until the end of this month.
