China Deflation Signals Deepen, Raising Stakes for Trade Talks; AUD/USD Holds Gains

China Deflationary Pressures Linger Ahead of US Trade Talks

China’s economy faced increasing scrutiny as markets prepared for US-China trade talks to resume on Monday, June 9. Inflation and producer price trends showed lingering deflationary pressures, reflecting a weakening demand environment.

Consumer prices fell 0.1% year-on-year (YoY) in May, mirroring April’s decline, while consumer prices dropped 0.2% month-on-month.

Producer prices painted a similar demand picture, falling 3.3% YoY in May, following a 2.7% drop in April.

Price trends in May aligned with the Caixin Composite PMI survey-based data, where average charges fell at the quickest pace in over two years as input cost inflation eased. Firms continued cutting prices amid intensifying competition.

 

US-China Trade Talks, Weakening Demand, and Stimulus

May’s inflation data underscored Beijing’s challenges to boost domestic demand and consumption. With deflationary pressures building and China’s Caixin Composite PMI falling below the neutral 50 level, Beijing may need to roll out fresh stimulus. However, Beijing may stay silent as US-China trade talks resume in London later today.

The outcome of today’s talks will likely impact risk sentiment more than the inflation data.

Market Reaction to China’s Inflation Report

The Hang Seng Index rallied to a high of 24,044 at the open. However, the inflation data led to a pullback, leaving the Index up 0.72% at 23,964.

In the forex market, the AUD/USD climbed to a pre-inflation report high of $0.65115. However, in response to the data, the pair dropped to a low of $0.65051 before steadying. At the time of writing, AUD/USD was up 0.26% to $0.65061.

However, US-China trade talks could be crucial for the AUD/USD pair’s trajectory. Given that China accounts for one-third of Aussie exports, the Aussie dollar remains sensitive to China’s trade data and US-China trade headlines. RBA Governor Michele Bullock recently highlighted the potential impact of the US-China trade war on the Aussie economy, stating:

“Australia’s economy could easily be compromised if a trade war between the US and China escalates. Depending on where we end up on trade developments, there might be more interest rate adjustments. But for now, rates are in the right place.”

What’s Next? Trade Data and Trade Negotiations

Later this morning, trade data from China will require consideration as markets look ahead to today’s US-China trade talks.

Economists forecast exports to rise 5% YoY in May, down from 8.1% in April, while expecting imports to fall 0.9% (April: -0.2%). Weaker-than-expected exports would likely reflect the impact of tariffs on demand for Chinese goods after the tariff front-loading in March. Exports soared 12.4% in March.

However, a larger fall in imports would suggest weakening domestic demand, aligning with the pickup in deflationary pressures.

While hopes of progress toward a trade deal may bolster demand for Hong Kong and Mainland China-listed stocks, softer trade data could challenge Beijing’s 5% GDP target. On the other hand, upbeat trade data and progress toward a trade deal could boost demand for risk assets.

Discover strategies to navigate this week’s market trends here.