China Finds Success; More Stimulus Incoming?

Chinese inflation figures were reported Tuesday night. The Chinese consumer price index came in at 5.5% while China's producer price index came in at 5.0%. Analysts had been expecting 5.5% for CPI and 5.8% for PPI, so the figures were together slightly better than expectations. China's drop in its CPI represented the biggest fall in the figure since February of 2009—when the country was suffering the effects of the global financial crisis. The fall in the rate of inflation may represent a significant victory for China's ruling party. The Chinese government has been working intensely to slow the growth of prices in the emerging economy. When compared to western developed nations, China's inflation has always grown at a greater pace. This may be largely due to the nation's significant growth rate—regularly averaging 10% growth per year—and currency peg policy. Many economic critics have alleged that China is actively manipulating its currency to keep it weaker than it otherwise would have been. This may lead to a higher rate of inflation in China's economy. Still, inflation has been tolerable for China in recent years for the most part. That is, until last November. At that point, inflation began to accelerate at a tremendous pace. Particularly food, as the price of some vegetables increased nearly 40% in a single month. As many in China remain impoverished, an increase in the price of food represents a significant decrease in the standard of living for the average Chinese individual. This may have contributed to riots seen in Southern China at the beginning of the summer. Some have said that the implementation of the second round of quantitative easing (QE2) was the driving force behind the sudden ramp-up in the rate of inflation in China. As China maintains a peg to the dollar, an increase in the supply of dollars through quantitative easing may have led to a forced increase in the supply of yuan, thus leading to the inflation seen in China. To combat the inflation, banking authorities in China have consistently worked to tighten policy. The data released Tuesday night seems to have shown that the Chinese have been relatively successful in their tightening efforts. So, will they look to continue easing? With inflation back in check, Chinese authorities may resume their efforts to continue expanding their growing economy. That might be bullish for Chinese stocks and for commodities. Yet, nearly everything was hammered across the board on Wednesday as concerns about Italian debt weighed on the markets. Despite the possibility of a rosy future in China, concerns in Europe may ultimately have a contagion affect on China, blunting any possibility for additional stimulus. ACTION ITEMS:

Bullish:
Traders who believe that the Chinese economy is set to continue its expansion might want to consider the following trades:

• Go long a Chinese ETF. A widely traded Chinese ETF is iShares FTSE China 25 Index Fund FXI.

• Make a bullish option bet on the price of copper. The Chinese economy is a massive consumer of copper and has sent prices of copper trading significant higher in recent years.

Bearish:
Traders who believe that despite the positive economic data, the Chinese economy will deteriorate may consider an alternate positions:

• Short industrials commodities, such as oil or coal. If China's economy stops growing, or even enters recession, the demand for these commodities may evaporate.

• Sell the AUD/USD. Australia's economy has grown tremendously in recent years, in part due to demand for its commodity exports from China. If China's economy falters, Australia may take a hit as well, and that could hurt the Australian dollar significantly.

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