Nancy Pelosi’s expected visit to Taiwan is dragging Asian shares lower this morning, with the Hang Seng and Shanghai composite indices both shedding over 2%. The geopolitical threat is very real. But investors are also getting another opportunity to sell into an escalating economic crisis gripping China triggered by falling land and property prices. Chinese new home sales slumped again in July. Data released by CRIC revealed that sales at the country’s top 100 developers fell 39.7% y/y, similar to the declines for May and June.
With property prices contracting on a y/y basis, the risk is that deflation will spread beyond housing to consumer goods and services. The NBS PMIs showed a renewed contraction in new orders for both manufacturing and non-manufacturing in July. Prices are falling and unemployment is rising. In the manufacturing sector, the index for producer prices dropped from 46.3 to 40.1. This portends an outright decline in the y/y for the official Chinese PPI, by year-end. Selling and input prices both fell sharply in non-manufacturing too.
China is weighing on US Treasury yields because the Chinese real estate market is one of the largest asset classes globally, and because China is about to export a renewed bout of deflation to the rest of the world through lower producer prices. The US ISM manufacturing prices index posted its biggest single month drop since June 2010, sliding 18.5 points to 60.0 in July.
The yield curve (i.e., the differential between 10-year and 2-year US Treasuries) has now inverted to 30 basis points. The 10-year UST and 3m T-Bill spread has also narrowed to just 4 basis points, down from 115 bps at the start of July. The deepening inversion of the yield curve (10-2s) is being taken as a positive signal by the US stock market because real yields have fallen. The 5-year real yield turned negative for the first time since June 9th, dropping to -0.06%.
But declines in real yields are not always positive for the stock market, particularly around economic downturns. Piling back into technology stocks because real yields are falling was a post-pandemic playbook that may not work this time around. China’s impact on global growth (to the downside) could pose significant risks.
