Albert Edwards: Market Is Blind To Deflationary Impulse From China

Last weekend, in “Dairy Aisle,” I talked a bit about the nexus between market expectations, consumer expectations and real-world, hard data.

The gist of that article (which I do encourage you to peruse if you missed it) was that the interplay between the media, speculators and consumer psychology could exacerbate the already self-fulfilling character of the phenomenon we call inflation.

Over the past several weeks, Chinese officials have embarked on a campaign aimed, in part anyway, at short-circuiting the self-referential dynamic whereby journalists, traders and consumers lose track of their own role in perpetuating a price spiral. On Monday, I suggested that campaign might be a semblance of successful and some of the commentary on Wednesday echoed that assessment.

In a Wednesday note, SocGen’s Albert Edwards broached these subjects. “Surveys suggest that inflation fears have become investors’ number one concern,” he wrote, before asking,

Why look at it that way? We could equally say it is investors’ own bullishness on the strength of this economic cycle that is driving prices sharply higher in the most cyclically exposed equity sectors and industrial commodities.

Yes, indeed we could.

When equities pull forward expected future outcomes, the worst that can happen is that things don’t work out the way bulls planned, causing stocks to “catch down” to reality, with subsequent losses for folks who, in hindsight, discover just how misplaced their optimism really was. Driving up commodity prices in a speculative manner can have more serious consequences for “real” people, something China pretty clearly intends to prevent.

“When [investors] pile into commodities as an investment vehicle to benefit from rising inflation, they create substantial upstream cost pressures,” Edwards wrote, noting that “beyond the cascading effect of upstream commodity price pressures, headline CPIs are also quickly impacted as food and energy prices rip higher.”

One might suggest that while the societal costs of other kinds of speculation often take years to manifest in a downturn, the impact of rampant commodities speculation is felt more immediately, perhaps making the case for more stringent regulation or, in the case of autocratic regimes, simple decrees.

But decrees aimed directly at commodities aren’t the only way Beijing can lean against higher prices. Chinese officials are keen to restart the de-leveraging push now that the crisis is in the rearview.

In addition to cooling speculation in the property market, mandates curtailing credit creation (figure above) could undercut commodity prices.

Copper, SocGen’s Edwards wrote Wednesday, is up 90% over the past year. Rather than measuring from the COVID-19 lows, he showed the 18-month change juxtaposed with a Chinese PMI component (figure below).

Beijing, Albert correctly assessed, is “getting annoyed by what they see as speculative excess and they’re cracking down hard.”

As ever, I’d remind folks that when Beijing gets “annoyed” at market participants, there are no congressional “hearings” or letters from lawmakers. Rather, there are “invitations” to closed-door “meetings” with officials during which the Party makes clear what it expects. Compliance is assured. Usually, those involved apologize even when they have nothing to apologize for. Sometimes, the targets of Beijing’s enforcement actions even thank the Party in comically obsequious statements.

In any event, the point is just that expectations may have run well out ahead of reality. When it comes to commodities, those expectations can become reality in the absence of intervention.

Even if you think I’m overstating China’s capacity to singlehandedly wrangle mischievous commodities by sheer force, simply curtailing the credit impulse might do the trick (figure on the right, below).

“Despite the euphoric optimism about the strength of the global economic cycle and its inflationary implications, investors may be in for a major cyclical shock – relative to expectations,” Edwards remarked, noting that not only does the Chinese credit impulse tend to lead closely-watched cyclical indicators, it also leads other macro trades including US Treasurys.

His conclusion: “While so many investors are focused on President Biden’s super-loose fiscal stance in the US, they’re missing the deflationary impulse heading down the tracks from China.”

Read more:

‘China’s Credit Impulse Just Turned Negative’

China’s ‘Pretty Evident’ Credit Slowdown May Bode Ill

Fearing Property Bubble, China ‘Instructs’ Banks To Slow Credit Supply: Report