China - Expect additional RRR cuts

Consumer inflation in May edged to a 15-month high, underpinned by a surge in cost of food – marking a seven-and-half-year high, with persistently high pork prices following an outbreak of the African swine fever. In contrast, underlying inflation eased to 1.6% y/y in May from 1.7% y/y in April, the lowest since August 2016. Likewise, factory gate prices softened to 0.6% y/y in May compared with 0.9% y/y in April.

The slower PPI signalled lacklustre manufacturing activities in the economy and these could derail further should the US-China trade war escalate further. At the same time, we noticed vehicle sales falling by 16.4% y/y in May from -14.6% y/y in April, marking the 11th consecutive month of decline.

Nonetheless, we maintain our view of 2H2019 easing considering the need to support consumption in a move to offset weak exports which account for around one fifth of China’s GDP growth in 1Q2019. Hence, we anticipate policymakers cutting the required reserve ratio rate (RRR), and will institute some fiscal stimulus measures. We are maintaining our 6.2% GDP growth for 2019 as our base case. In the event of a full-blown trade war, we need to reduce the GDP growth by 0.6%–1.5%.

• Consumer inflation in May edged higher to 2.7% y/y from 2.5% y/y in April. The latest print marked a 15-month high, underpinned by a surge in cost of food (7.7% y/y from 6.1% y/y) – reaching a seven-and-half-year high, with persistently high pork prices (18.2% y/y from 14.4% y/y) following an outbreak of the African swine fever.
• In contrast, underlying inflation – which excludes volatile items such as food and energy prices – eased to 1.6% y/y in May from 1.7% y/y in April, the lowest since August 2016. Likewise, factory gate prices softened to 0.6% y/y in May compared with 0.9% y/y in April. The slower PPI signalled lacklustre manufacturing activities in the economy and these could derail further should the US-China trade war escalate any further.
• At the same time, we noticed vehicle sales falling by 16.4% y/y in May from -14.6% y/y in April, marking the 11th consecutive month of decline. Despite the country’s automotive sector showing no sign of easing, the industry now braces for new emission standards due to come into effect 1 July, a year sooner than planned. Looking at the current regulations, this may add additional pressure to the already weak automotive sector.
• Despite the consumer inflation surging high, we do not expect the central bank to tighten its policy given that it is driven by supply side factors while both core inflation and factory gate prices are easing. Nonetheless, we maintain our view of 2H2019 easing considering the need to support consumption in a move to offset weak exports which account for around one fifth of China’s GDP growth in 1Q2019.
• Hence, we expect policymakers to cut the required reserve ratio rate (RRR), each by 50 basis points from the current 13.5% in 3Q2019 and 4Q2019. The policymakers will also institute some fiscal stimulus measures. We are maintaining our 6.2% GDP growth for 2019 GDP as our base case while inflation is forecast at 2.2%. In the event of a full-blown trade war, we need to reduce the GDP growth by 0.6%–1.5%.

US - Brace for July rate cut

Headline consumer price index (CPI) fell short of expectations of 1.9% to record an annual growth of 1.8% y/y in May from 2.0% y/y in April. The core CPI, which excludes energy and food cost, slowed down to 2.0% y/y from 2.1% y/y in April. The slower price pressure in May reinforces the case for the Federal Reserve to cut interest rates. Given that a slew of economic release recently continues to disappoint and falling short of the Fed’s parameter amid rising trade tensions with China and fading fiscal stimulus, we believe the US economy is starting off on a fragile footing in 2H2019. This further bolsters the case for the Fed to signal an easing bias during next week’s FOMC meeting. Having said that, we should brace for a July rate cut.

• Headline consumer price index (CPI) fell short of expectations of 1.9% to record an annual growth of 1.8% y/y in May from 2.0% y/y in April. The core CPI, which excludes energy and food cost slowed down to 2.0% y/y from 2.1% y/y in April. The slower price pressure in May reinforces the case for the Federal Reserve to cut interest rates.

• The tamer inflation print in May was primarily driven by a fall in energy cost, down 0.5% y/y from a gain of 1.7% y/y in April, which offset the gain in food prices, up 2.0% y/y in May from 1.8% y/y in April. We also noticed that inflation for transportation services remained unchanged at 1.1% y/y in May while used cars slowed down significantly to 0.3% y/y from 0.8% y/y in April.

• Though the core CPI is still clinging on to the Fed’s 2% inflation target, it tracks a different measure for its monetary policy — the core personal consumption expenditures (PCE) price index. The core PCE price index rose 1.6% y/y in April from 1.5% y/y in March, but still a far cry from the Fed’s 2% target.

• Given that a slew of economic release recently continues to disappoint and falling short of the Fed’s parameter amid rising trade tensions with China and fading fiscal stimulus, we believe the US economy is starting off on a fragile footing in 2H2019. This further bolsters the case for the Fed to signal an easing bias during next week’s FOMC meeting. Having said that, we should brace for a July rate cut.

Source: AmInvest Research - 13 Jun 2019