Deflation in China will deepen until January. Spring may see a thaw in overpriced Chinese shares

In the last months of 2023 and early 2024, China's economy has been struggling with deflation and will continue to struggle with it, which is quite an unusual phenomenon in a global context where most countries are struggling with inflationary pressures. China's deflation resulted from several key factors.

Firstly, weak domestic demand had a significant impact on the situation. The government focused its activities more on supporting production and investment than on stimulating consumption, which contributed to reducing consumer spending. Additionally, high levels of household savings in the face of economic uncertainty also limited consumer spending.

The second important factor was the decline in the real estate market. This sector plays an important role in the Chinese economy, and its weakening had a direct impact on the country's overall economic situation. Reduced demand for real estate led to falling house prices, which in turn had an impact on deflation.

In addition to these domestic factors, deflation was also driven by global trends in commodity prices and a weakening global supply chain. Reducing global demand for raw materials and services also had an impact on the situation in China.

In the geopolitical context, a change in the dynamics of China's international trade was observed, with trade relations with the US becoming less important and trade with Russia increasing. These changes have also affected the Chinese economy, especially amid tensions over the war in Ukraine and international pressure to isolate Moscow.

Deflation, while it may suggest lower prices for consumers, poses a risk to the economy because it can lead to a cycle in which consumers postpone purchases in anticipation of further price declines. Lack of demand can force companies to reduce production, freeze hiring or layoffs, and lower prices of existing stocks, impacting companies' profitability while costs remain the same.

China has taken a number of stimulus measures to support key sectors, in particular the problematic real estate sector. However, it is unclear whether these measures will be sufficient to offset deflationary pressure in the economy. As a result, both analysts and policymakers are closely monitoring developments, given China's significant role in the global economy.

Deflation in China – what does the future hold?

It appears that the solstice will be reached in January due to the base effect from last year. Therefore, after the January solstice, there is a chance that deflation will still occur, but it will be smaller, and by the holidays we can even expect inflation, i.e. an increase in prices on an annual basis. As a result, a positive impact on the Chinese stock market, which has recently been significantly devalued, is possible.

China waiting for the Fed?

There is a problem in China, waiting for the American one Federal Reserve and its actions. China must keep yields at the short end of the curve relatively high so as not to weaken the yuan, but yields at the long end are falling. This is not a favorable situation for the stock market. It may be beneficial when yields at the short end fall or stop rising and start rising at the long end. This will be possible if the Fed decides to cut interest rates and when the deepening deflation in China ends. This could be a favorable set of events for the Chinese stock market.

Instrument Hong Kong 50 on the CMC Markets platform fell by 2023% from January 2024 to January 28 and is close to the October 2022 low.