UBS On-Air: Paul Donovan Daily Audio 'Deflation and inflation'
The desk interprets the emergence of deflation in China as a critical signal, highlighting domestic growth concerns amid global uncertainties. Per the full note source, the unexpected deflation in consumer prices, worsened by seasonal factors such as the Lunar New Year and weather-induced food price adjustments, underlines a challenging economic landscape that appears incongruent with the Chinese government's growth targets. Given the nuanced inflation picture in China, which contrasts sharply with recent inflationary pressures in the U.S., traders may need to reassess their positioning in related currency pairs going forward.
What the desk is arguing
The desk frames this as an indication that China's economy may be losing momentum, contradicting the government's reported growth rates. The drop into deflation, more pronounced than expected, raises concerns about consumer spending and overall economic vitality in the lead-up to key policy decisions from the People's Bank of China.
The consumer price index (CPI) for February not only showed deflation but fluctuated significantly due to seasonal changes, with food prices—having greater weight in the inflation basket—falling markedly due to warmer weather. The implication is that the economic fundamentals may not align with the political narrative aimed at achieving a 5% growth rate this year.
Where it sits in our coverage
Consensus on the USD/CNY pair is currently centered around 1.075 with a range of 1.04 to 1.12. Notably, some institutions such as jpmorgan have a target of 1.10 for March 2026, reflecting an expectation of moderate appreciation of the dollar against the yuan.
This view diverges from bofa, which holds a contrary target of 1.04, indicating a belief that the CNY could strengthen in the face of economic recovery in Asia amidst global uncertainties. Thus, our current positioning aligns closely with those anticipating a weaker yuan given the current inflationary signals.
How other firms see it
Firms aligning with a bearish view on the yuan, like jpmorgan, see the deflationary trend as a precursor to continued economic sluggishness. In contrast, firms such as bofa argue for potential strength in the Chinese currency based on other economic factors that may support its value.
In this context, traders should keep an eye on trends in USD/CNY, particularly how upcoming data could reflect the PBOC's responses to economic pressures. Additionally, U.S. inflation dynamics, especially following any further tariff discussions, can provide critical context for currency movements across the board, particularly in relation to the USD.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01China's unexpected deflation signals potential domestic growth issues.
- 02Consumer price fluctuations, influenced by seasonal factors, complicate the inflation narrative.
- 03Divergence exists among firms regarding future currency valuations, reflecting differing economic outlooks.
Market implications
Watch for movement around the 1.075 mark in USD/CNY as traders react to China's inflation data and potential PBOC policy shifts. Continued pressure from U.S. inflation data could also influence the dollar's performance against the yuan.
Risks to this view
The call could be invalidated if China's economic data in the coming months defy expectations, indicating stronger recovery. Additionally, unexpected changes in U.S. fiscal policy or inflation pressures could lead to a reversal in USD/CNY dynamics.
Good morning, this is Paul Donovan, Chief Economist at UBS Global Wealth Management. It's 7 o'clock in the morning London time on Monday the 10th of March. China's consumer price inflation number for February came in as deflation, and more deflation than had actually been expected.
Some of this drop in prices is due to the timing of the Lunar New Year holiday, as that festival is not fixed and the data presented comes in a year-on-year format. Warmer weather lowered food prices by increasing supply, and food is more important in the calculation of China's inflation rate than is the case with developed economies. Without getting too worked up about deflation, China does seem to remain in an exceptionally low inflation environment.
This sort of picture is not necessarily consistent with the reported 5% economic growth of last year and the aspiration of 5% economic growth this year. Markets seem to be taking this as a signal of domestic growth concerns at a time when global growth and trade are also under threat. US President Trump is potentially facing a different issue, namely a risk of higher inflation in the wake of tax hikes for US consumers.
Of course, Trump's tariff policy has been unpredictable, with a series of retreats so rapid they almost collide with the next tax hike announcement. However, even where there are retreats, there may still be price increases. The direct effect of tariffs is only part of the inflation impact.
The second round effects are often the more important. The rather chaotic US tariff policy still allows companies to sell a story to their customers to cover for price increases, and some may also try to raise prices in anticipation of tariffs that actually end up being retreated from. The New York Fed's survey of inflation expectations is due today, but this needs to be treated with considerable caution.
Not only are consumers very, very bad at assessing inflation with any accuracy, there is also an added layer of political partisanship to be factored in. Trump also declined to say whether a recession would be avoided in the United States. After the US economy achieved a soft economic landing in 2024, markets are now starting to get more concerned about the prospects for growth in 2025.
Some of this is just about animal spirits. If fear increases, consumers are less inclined to spend, and companies are less inclined to invest. Measuring that is difficult, but the last couple of months have seen some expressions of vulnerability.
Depending on imported components, or on being able to export, is obviously threatened by tariff policy, and any rise of anti-US sentiment may have an impact on some exports in addition. There are, for example, some consumer boycotts in countries like Canada. While the loss of federal government jobs is not directly of much economic significance, companies that interact with the US government may find the decline in government efficiency, or insecurity about government payments, a hindrance to doing business.
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