- China’s latest export: deflation. While the rise, falter and subsequent intervention in Chinese stocks seems spectacular, the larger issue remains China’s economic outlook. The perception is China suffers from a loss of credibility and questions about its ability to implement further reforms. And the reality is markets are reacting to weak economic data (ignoring the roundly questioned official second quarter figures) as well as capital outflows. The upshot: A flatter Chinese economic outlook is renewing declines in commodity prices.
- Wages vs. commodities. Falling commodity prices reflect global growth concerns, primarily from China, and point to important shifts in the fixed income investment landscape. Already inflation expectations have followed commodity prices lower, unwinding some of the year’s earlier recovery. Where today the market focuses on declines in headline inflation, over the longer run, the focus should be on core. Here the outlook for wage inflation becomes the important factor. Yet the latest indicators point to few signs of rising wage pressure despite tightness in labor markets. Eventually, that pressure will emerge.
- Credit risks and opportunities. Falling commodity prices significantly impact the outlook for credit investments. Declines in energy prices relate not only to supply factors (e.g., U.S. shale and inventories, Iran and Saudi supply), but also to prospects for easing Chinese demand. Falling prices for oil and iron ore reflect the weakening China outlook. The impact on credit has been substantial, with some energy- and metals-related bonds falling 10–25 points. Declines of that size suggest both rising risks and opportunities for credit investors.