All eyes should be on China

Investors are currently enjoying positive surprises regarding inflation, mainly in the USA, where it fell more than expected this week. Both the consumer price index (CPI) and producer price index (PPI) surprised with their larger y/y declines in June, reaching 3 percent and 4.8 percent, respectively. Market bulls welcomed this news, as it could mean that after the July hike, the Fed will halt its rate hike cycle and even begin cutting rates early next year.

However, how to deal with disinflation and then deflation should be demonstrated in China. It is precisely there that deflation is knocking at the door and poses a threat to the emergence of a deflationary spiral amidst a slowing economy. Deflation naturally causes the economy not only to cool down but also to potentially collapse.

"There has been recent media coverage about China flirting with deflation. However, if nothing changes, China is likely to fall into deflation in July or October on a y/y basis, thanks to the base effect and prevailing trends since the beginning of the year. On one hand, this poses a significant threat to a deflationary spiral, but on the other hand, it raises hopes for a powerful stimulus to avoid deflation in the Chinese economy.

Furthermore, the situation in China can be a good indicator of what central banks, governments, and markets can do if deflation knocks on the doors of Europe or the United States. It seems that key markets to watch include ETFs on emerging markets with significant exposure to China, such as EEM, as well as the copper market and the Hang Seng Index," Daniel Kostecki, Financial Market Analyst at CMC Markets Poland, said.

(WBJ)