- Poor manufacturing sector data out of China has global markets off to a shaky start in 2019.
- An analyst at Japan’s Mizuho bank has highlighted how the downturn is not just worrying for how steep it is but for its timing and the fact that part of it is driven by the US-China trade tensions, for which there is no predictable path to resolution.
The rocky start to the year on global markets was in part a continuation of December’s sell-off but a compounding factor was the weak data on China’s manufacturing sector.
A survey showing a contraction in manufacturing activity in the world’s second-largest economy was much worse than expected. It suggests not just that the Trump administration’s trade tariffs are biting but also that China is decelerating at a greater rate than anyone was anticipating.
The purchasing managers’ indices, or PMIs, are closely watched by many investors as a leading indicator of global growth. Research from Capital Economics published last month found the PMIs had a far greater correlation with global GDP growth than any other data set.
PMIs are presented as a diffusion index, based on questionnaires sent to businesses. A reading above 50 signals that activity levels are increasing while a figure below suggests they’re contracting. The distance away from 50 indicates how quickly activity levels are expanding or contracting.
So when China’s manufacturing PMI for December came in at 49.4 — down from the 50.0 the previous month which suggested stability in the industrial sector — it came as a nasty surprise.
This morning, partly in response to the data, the Australian dollar was trading below US70c for the first time in three years.
Vishnu Varathan, head of economics and strategy at Japanese megabank Mizuho, has outlined a long list of reasons that that data is troubling not just for China but for Asia more broadly and the rest of the global economy — especially as the political uncertainty means the slowdown currently being measured in Chinese manufacturing could spill into other areas of business activity, including capital investment planning.
Here’s a summary of the points in Varathan’s note to clients:
1. The PMI survey has been weakening for months and we are just about to hit what is traditionally the weakest point of the year for China’s manufacturing sector. January and February take in the Lunar New Year holiday when much of China shuts down. Varathan points out that the “sustained Mfg PMI downturn in in H2 2018 with emphatic year-end slide is potentially symptomatic of far sharper underlying demand pullback.”
2. The speed of the demand pullback “is significantly more pronounced, with a 2.1-point drop over six months” compared to recent years; it’s the steepest since 2011.
3. New export orders are crashing, potentially masking the severity of the drop in demand for manufactured goods so far. Look:
4. It’s not cyclical: parts of the downturn are being driven by the US-China trade war, making it extremely difficult to predict when there might be a recovery. The future shape of demand for Chinese exports is contingent on political negotiation and it’s impossible to know what shape this might take — and whether both sides will then stick to their respective sides of the bargain. Varathan notes the “harder-to-predict nature of this downturn entailing greater uncertainties” which “related to on-going threat of US-China trade escalation coming to roost in 2019 … render assumptions about cyclical bottoming cyclical are less applicable/comforting.”
5. This unpredictability means the downturn might not be contained to the manufacturing sector. Varathan said: that “elevated uncertainty and binary risks associated with US-China deal making (challenged by Trump’s penchant for shifting goal-posts) means wider business and investment activity could also be under more stress in 2019.
6. Finally, the China PMI tends to lead demand in Asia; so, Varathan argues, “exporters in Asia as a whole are faced with similar risks as the extensive and dominant trade- and investment-linkages to China means negative shocks to China’s exports and manufacturing will reverberate more widely to other Asian exporters.”
This chart shows the relationship between the China manufacturing PMI and export levels from other key Asian emerging markets.
Australia has the highest exposure of any country in the world to China’s economy. Around 27% of all Australia’s trade — imports and exports — is with China.
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