Lately the headlines have focused on Greece and the Eurozone mess, but perhaps it is China that really holds the key to whether the global business cycle will begin to recover in the second half of 2012. A year ago China was fighting inflation and tightening reserves in an effort to take the froth out of the property market and to reverse the commodity inflation that threatened emerging market populations (which are more vulnerable to spikes in food and energy prices then their developed world counterparts). The good news is that last year’s tightening has worked, with year over year inflation dropping steadily. Unfortunately for China, they might have overdone it bit: Growth rates have been dropping at a worrisome pace over the last quarter or so. Many measures of Chinese growth have been decelerating for months, including yesterday’s manufacturing Purchasing Managers Index, which came in below expectations at 48.7. The day also brought news that the nation’s biggest banks are likely to fall short of loan growth for the first time in seven years. The bears are grumbling that China might be caught between a housing collapse and Europe’s recession.
Despite some of the poor data, there are plenty of cross currents in play that contradict the bearish scenario. The most compelling is that that the entire emerging market zone is in growth supporting rate cutting mode. It is also notable that the Organization for Economic Co-operation and Development (OECD) leading indicator for China was recently revised up and looks much better than the poor coincident data that has been printing lately. Even so, weak commodity and Chinese equity prices seem to be sending a message that China is still behind the curve and experiencing the lagging effect of policy tightening. The bullish spin is that falling inflation and weakening data give China’s policy makers cover to implement a very powerful stimulus plan, and the Chinese premier may have tipped what is coming when he publicly stated that China will focus on bolstering economic growth. If China flexes its muscles, it could be a game changer for the global business cycle, risk assets, and commodity based risk assets that have been dragging.