China's soft PMI indicates Q3 growth below 7%

The Caixin/Markit flash PMI surprisingly fell to 47.0 in September from 47.3 last month, against market expectation of a modest rise to 47.5. This is the lowest reading since March 2009 and suggests that Chinese growth in Q3 is likely to break below 7%. Chinese equities initially responded negatively and edged more than 1% down. The CNH initially trended lower vs the USD, more than the weakening of the central bank midrate, but later corrected.

The weak headline reading was consistent with soft sub-indices across the board. Output fell to 45.7, lowest since 2009, new orders to 46, lowest since 2011, finished goods stocks rose to 53, the highest since 2012. Falling orders and inventory build-up is a bad cocktail for industrial production, which is one of the macro indicators most closely correlated with GDP growth.

Given the much softer PMI reading in Q3 than in Q2, real GDP growth is very likely to break below 7% seen in both Q1 and Q2 this year, says Nordea Bank. The on-going housing market recovery and the accommodative monetary and fiscal policy are clearly insufficient to offset the structural downward pressure from industrial overcapacity and declining return on investment. In addition, Q3 growth would be marked by the stock market crash during the summer through sluggish consumption and service sector activities.

"China's Q3 GDP growth is anticipated at 6.6%, much below the consensus expectation of 6.9%.  We see more policy in the pipeline, with one rate cut of 25bp and two more RRR cuts of 50bp each. This measures are likely to boost growth to 6.8% in Q4, resulting in a whole-year growth to be 6.8%", states Nordea Bank.