China rallies as manufacturing softens

HSBC says factories in China are tapping the brakes and inflation-weary traders are greeting the news with applause.

According to the “flash” PMI, which comes out 10 days before the official manufacturing numbers, Chinese factory activity has leveled off at a level of 50.1 — an 11-month low, but still reflecting marginal growth.

While some of the reporting around this has raised alarms that the wheels have fallen off the Chinese economic engine, traders are actually more interested in the output and input price subindices, which apparently reveal that inflation is slowing.

This, in turn, gives the markets hope that Beijing may be able to stop its anti-inflationary campaign of raising bank reserve requirements some time soon.

The reserve requirement hikes have drained a vast amount of liquidity from the Chinese economy by locking that cash up in bank balance sheets.

The goal here is to curb lending and so hobble the demand factors that have driven consumer prices higher.

At least, that has been the theory, and last night’s numbers indicate that it might finally be working. Most economists expect that June will be the peak of the current inflation cycle and we tend to agree.

As it is, NDRC economic advisor Chen Dongqi reportedly says reserve requirements may slow or even come down in the second half of the year, although he admits that an outright interest rate hike or two may still be in the cards.

Check out the tick chart on Shanghai (quote) to see how the markets reacted to this bit of news, and then look at Mumbai (quote) — another vast market struggling with inflation fears — for the follow-on effect.

Both China and India traded well last night despite a lot of global noise.

In China, interestingly enough, “socialized housing” stocks fared best as traders hoped a return to the old lending standards could boost construction. Cement companies gained 4% to 10% and steel makers added 1% to 3%.