Posted on September 23, 2015

China Weakness Could Postpone Fed Rate Hike

A significant slide in a preliminary measure of China’s factory activity for September is getting more attention than usual because Janet Yellen mentioned concern about China’s economic outlook as a reason for Fed caution. This reduces the odds of a rate hike in October.

Data released in China last night showed that companies are struggling across the board. Subindexes for output, new orders, new export orders, employment, prices and inventories all weakened more than expected. The preliminary Purchasing Managers’ Index from Caixin Media and Markit Economics posted its lowest reading in 6-1/2 years. In consequence, Asian stock markets sold off sharply.

The collapse in new export orders suggests that global trade is facing headwinds–a concern for both the Canadian and U.S. economies. As the second largest consumer of energy, oil prices are also vulnerable to what has been a sustained slowdown in China. Beijing will clearly miss its roughly 7 percent target growth rate this year, the slowest pace in 25 years.

The two drivers of growth in the past, manufacturing and fixed-asset investment, have slowed sharply this year. Investment in real assets, such as residential and commercial real estate construction, rose at its slowest pace in 15 years. This has reduced Chinese demand for industrial materials, putting downward pressure on prices.

Excess capacity across a number of industries in China, as well as weakness in domestic and international demand, are major challenges facing Chinese factories. Finished goods inventories rose sharply, pointing to a further drag on industrial production in the near term.

The TSX materials sector is down more than 28 percent year-over-year and the TSX energy sector has plummeted more than 37 percent over the same period. Alberta and Newfoundland are in recession and Saskatchewan’s economy has weakened. Continued weakness in China spells further bad news for this part of the Canadian economy, pointing towards further weakness in the Canadian dollar and potential further rate cuts by the Bank of Canada.