Two very interesting trends have emerged in China recently; 1. the re-ignition of the Chinese property bubble; and 2. the seemingly impending end of producer price deflation. The two trends are inter-related, and with the release of the August 70 cities property price data for China it’s worth examining these trends and the likely end game.
1. Property prices surging once again
August brought with it another round of property price gains in China with newly built properties up in 64/70 cities an average of 1.2% m/m and second hand property prices up in 57/70 cities for an average 0.9% m/m gain; leaving prices up an average 7.4% and 5.8% y/y respectively. The chart below shows the stark turnaround in Chinese property prices following the sharpest drawdown in recorded history during 2014/15. The drivers of this rebound are largely policy related (cutting interest rates, cutting minimum required deposits, cutting sales tax, and cutting hukou requirements in the smaller cities). In a bubble driven economy once you set the forces in motion it can quickly get a life of its own…
2. Property price inflation leads producer price inflation (deflation)
While the property price surge is not sustainable longer term due to the supply overhang from years of credit-fuelled over-building, it can continue in the short run. When property prices go up it (rightly or wrongly) sends a signal to developers that people want more property and so the developers begin to build. This is a long winded way of pre-explaining the relationship I’m about to note in the chart below. In China there is a pretty clear link between producer price inflation and property price inflation. This relationship broke-down in the 2013 property price surge because the inventory overhang was more intense at that point and the commodity supply glut was beginning to emerge. At this point supply has begun to adjust, so it would be reasonable to expect that Chinese producer price inflation will follow property price this time, albeit with a lag.
A new property price bubble is good news for the short-term cyclical outlook, and bad news for the medium term structural outlook for China. It provides a welcome source of strength as other parts of China’s economy, e.g. exports, industrial production, splutter… and helps take the China risk off the table for now (placing that risk at a more precarious position somewhere later in time).
For those outside of China it’s great short-term news too, particularly commodity producers (at least those that managed to survive the carnage of the past couple of years). Emerging market equities as a whole also tend to do better when China is seeing rising producer price inflation (and badly when China has PPI deflation), as I noted in a previous article.
It will also tend to put a modicum of upward pressure on global inflationary forces too, however transitory that might be; which aside from potentially lifting confidence could cause central bankers to show a degree of constraint in their battle to find inflation…
Bottom line: China’s new property price bubble is good news in the short-term for the cyclical outlook in China and emerging markets/commodity producers, but a bigger hangover will likely loom.