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SPI Management Newsletter 11.08.23

Deflation Strikes China, Posing Global Economic Concerns

China experienced a decline in consumer prices for the first time in two years this July, marking a concerning phase for the world's second-largest economy. Several challenges, including a decline in exports, increased youth unemployment, and a faltering housing market, have been dampening China's economic recovery.

Goods, ranging from daily essentials like vegetables and home appliances to commodities like steel and coal, are witnessing falling prices. This deflationary trend contrasts sharply with many countries that have been grappling with inflation post-Covid-19 restrictions. While China's consumer prices dropped 0.3% in July from the previous year, core inflation, which excludes volatile food and energy costs, saw a rise to 0.8%.

Deflation can be harmful, especially for nations with significant debt like China. Lowering expectations could further decrease demand, complicate debt burdens, and trap the economy, making traditional stimulus methods less effective. In 2022, China's total debt was almost triple its GDP, surpassing the U.S. ratio.

While Western countries have seen inflation prompt central banks to hike interest rates, China’s economic challenges differ. In the U.S., for instance, June witnessed a 3% consumer price increase, the slowest rise in over two years.

China's lack of inflation highlights the imbalance in the economy. Domestic demand remains subdued, largely due to inadequate social security support for households. The continuous challenges from the pandemic and growing uncertainties, including in the real estate sector, have significantly impacted consumer confidence.

Future actions might include further interest rate cuts by China's central bank. However, with declining confidence among businesses and households, only significant measures might effectively counter deflationary pressures. Experts believe China needs a robust response to address deflation and boost its economy.

Europe's Energy Reliance Highlights Global Market Volatility

Europe's shift from Russian energy to liquefied natural gas (LNG) has made it more susceptible to global energy market fluctuations. After the start of the conflict in Ukraine, Europe sidestepped an energy dilemma by boosting LNG imports, substituting Russian pipeline supplies. However, this pivot has tethered European prices to global energy disruptions, including those as distant as Australia.

European gas prices soared by 40% this week due to looming strikes at Australian LNG projects, which contribute 10% to the world's seaborne gas. This price surge also pushed traders who anticipated a dip to hastily reverse their short stances.

Goldman Sachs has raised concerns, suggesting European prices might even triple this winter. Before the Ukraine crisis, European gas was significantly buffered by Russian supply, which contributed to 40% of its needs, while LNG was at 20%. However, in the aftermath, LNG imports rose to 34% and are projected to climb to 40% in 2023.

Although Australian LNG doesn't directly cater to Europe due to high shipping costs, any diversion in Asia's supplies, where major importers like Japan, China, and South Korea reside, could intensify competition with Europe's rising LNG demands. This situation could give rise to a bidding war for U.S. volumes between Europe and Asia, according to Rystad Energy's Kaushal Ramesh.

European gas benchmark, the Title Transfer Facility, experienced a 7.5% decline recently. However, storage, pivotal for winter needs, is nearing its full capacity. Kaushal Ramesh warns that while Europe has substantial reserves, the unpredictable winter might quickly deplete them. He also noted that to continue LNG imports, European gas prices should remain competitive with Asian rates.

Goldman Sachs’ Samantha Dart highlighted the precarious situation, indicating that potential Australian strikes and unpredictable winter conditions could deplete Europe's storage by March 2024, necessitating high prices to regulate storage levels.

Adapted from WSJ, FT, NYT, Reuters, CNBC, Bloomberg

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