DXY rebounded with risk overnight:
The Aussie was weak against both majors:
It was also weak against other EMs:
The Brent short squeeze ended with a bang:
Base metals rose:
Big miners too:
EM stocks bounced:
High yield too:
US yields rose but the curve flattened:
European spreads tightened:
And stocks launched:
The next problem for the reflation trade is China. The leading edge of the expected slowdown is here and metals prices are not ready. Via Capital Economics:
• China’s July activity and investment data showed a marked downturn and reversed most of the gains recorded towards the end of the second quarter. We had always expected policy tightening to translate into slower growth in the second half, but we think prices have yet to reflect this view.
• Data released today showed that growth in headline industrial production dipped to 6.4% y/y, down from 7.6% in June. (For more, see the China Data Response sent to clients of our China service earlier this morning.) The data were at odds with the jump in the unofficial July manufacturing PMI reading (see Chart 1) but were more in line with the official PMI, which eased back last month. Of course, while the growth rate slowed, expansion of 6.4% y/y is still strong by most standards.
• There were also across-the-board falls in the underlying data on industrial output – which we think are more reliable than the headline figure. (See Chart 2.) In particularly worrying news for metals demand, construction starts declined sharply. Growth in property sales has also slowed and is now at its weakest level since 2015. (See Chart 3.) That said, construction starts are a volatile indicator and we would need to see a couple of months of weaker data before being sure that a slowdown was underway. However, given government efforts to cool the property sector, this appears likely.
• The investment data were also less positive. We estimate that growth in nominal investment dropped to just 6.8% y/y in July, down from an average of 8.6% in the first half of the year. Weaker capital spending was particularly evident in private sector manufacturing firms, but growth in property and infrastructure investment also softened. (See Chart 4.) Retail sales data, also released today, corroborated the broad trends in the activity data. Car sales slackened along with sales of products linked to the property cycle, including furniture and white goods.
• While the nickel price has been pushed and pulled by prospects for mine supply, the downturn in China’s stainless steel output has been an additional factor undermining market sentiment. (See Chart 5.) Admittedly, there are early signs that production picked up in July (official data are not available yet), which could put a floor under nickel prices. However, after a 12% y/y rise in China’s stainless steel output in 2016, stocks are still comfortable and producers are facing mounting international protectionism.
• Staying with steel, today’s data also showed China’s crude steel output rising by around 10% y/y to a new monthly record of 74m tonnes in July. A combination of soaring Shanghai steel prices and the prospect of government-led curbs on output later in the year incentivised production. Indeed, with the weakness in the construction sector depressing demand, our estimate of steel net-demand growth (the demand proxy minus supply) plunged in July. We think there would have to be a marked downturn in supply later in the year or a surge in demand (which appears unlikely) for the strength in prices to be justified.
• The latest activity data have weighed on all our in-house proxies for China’s metals demand (which aim to capture trends in physical demand from end-users). However, looking at the net-demand picture for aluminium, a drop in supply in July means that the index has actually ticked up. (See Chart 7.) Aluminium production fell by over 8% m/m and was up only 1.2% y/y in July. It appears likely that government efforts to clamp down on illegal production are starting to have an impact. However, production has still risen by 9.3% y/y in the first seven months of the year and China-based stocks have soared, suggesting that supply remains comfortable for now.
• Vehicle production and sales remained weak in July. Although the construction sector is a much larger source of copper demand, copper usage in the transport sector has been rising rapidly in recent years. Although much of the latest rally in copper prices has reflected concerns about supply, Chart 8 suggests that demand is unlikely to offer any support to prices going forward.
• We do not want to read too much into one month’s data, but the softer trend is consistent with the scale of policy tightening so far this year. We continue to expect somewhat slower activity in the second half of the year to lead to lower metals prices.
The slowing will be gradual but material so the commodity reflationary pulse is about to enter reverse. The question for local investors now is how will the commodity deflation, that has resumed with oil and will expand into metals across H2, impact the USD and AUD?
The USD has deflated a lot as USD tightening expectations have dropped. I remain entirely skeptical that we’ll see any more Fed action this year as the oil shock deepens. If so, DXY may have one more bout of weakness ahead.
Offsetting that, the fundamentals of metals prices are clearly eroding in China. Inventories are high, demand is coming off and supply has rebounded.
These two forces are best thought of as monetary versus real influences upon commodity prices. We’ve been through a period when both a falling USD and good Chinese growth supported prices. Now at least the latter is fading. The former might have further yet to run.
The two combined to put a double rocket under the Australian dollar. With one rocket sputtering there is a growing chance that the Aussie dollar has already peaked.