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China's Challenges Pile Up as Factories Slow Amid Trade Standoff

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China's Challenges Pile Up as Factories Slow Amid Trade Standoff

China's Challenges Pile Up as Factories Slow Amid Trade Standoff

(Bloomberg) -- China’s manufacturing sector slowed more than expected and further signs of stress in the labor market appeared, adding to a weakening currency and financial nervousness on the list of problems faced by President Xi Jinping as the trade war worsens.

The manufacturing purchasing managers’ index for May slid into contraction at 49.4 and its employment sub-index tumbled to the lowest level since the aftermath of the global financial crisis. The yuan has fallen 2.5% in May, and stocks had a tough month as turbulence from Trump’s tariff hike hit home. If that wasn’t enough, the first government seizure of a Chinese bank in 20 years also has spooked markets.

Worsening data and anxious markets leave President Xi Jinping walking a tightrope as he tries to stand firm against Trump while supporting growth without a debt blowout. Trump’s widening of his tariff campaign to Mexico bodes ill for China’s chances of rapprochement with the U.S. -- though a potential meeting between the two leaders at a Group of 20 summit in Japan next month could yet produce a turnaround.

“One really worries what the data are going to look like into the second half as the global backdrop and the local economy both turn down together,” said Michael Every, head of Asia financial markets research at Rabobank in Hong Kong. “It’s a question of when, not if, we see U.S. 10-year yields below 2% and the yuan above 7.”

The employment sub-index of the official non-manufacturing index also sank to the worst in more than three years. While the factory indicator has been in a gradual multi-year decline due to automation and younger people opting out of the sector, a sharp contraction in the peak production season underscores that the trade war is hurting on the ground.

Jobs are a red line issue for China’s leadership, which this month established a leading group headed by a vice-premier to support employment and vowed to “defend the bottom line of avoiding massive lay-offs.” Premier Li Keqiang also pledged to meet the annual employment target and top economic officials unusually requested provinces keep migrant workers in their work locations and avoid them returning to hometowns “in large tides.”

A sub-index gauging new export orders in the manufacturing index also fell further into contraction. That suggests that exporters felt the squeeze of renewed tariff threats from the U.S. and waning global demand, implying that the apparent recovery in the first half has been short-lived amid a sudden escalation of the trade war.

Policy makers may take comfort from the relatively robust outlook for services and construction, with the non-manufacturing remaining at 54.3. That said, analysts point to the increasing headwinds beginning to feed through at home.

“The momentum of the economy is continuing with the softer trend we saw in April,” Grace Ng, a China economist at JPMorgan Chase & Co. in Hong Kong, said on Bloomberg Television. “Now on top of that, there is the complication from the escalation of tariffs from the U.S. which will then drag on the export sector which will feed through to the domestic economy.”

Risks are also flaring in the nation’s $42 trillion financial industry after the first government seizure of a Chinese bank in 20 years spooked markets. The takeover of Baoshang Bank Co. last week came as the country’s smaller lenders grapple with record corporate defaults and a regulatory crackdown on shadow-banking activities. The central bank moved to curb the risk of a interbank funding squeeze with the largest net injection of cash since January.

Policymakers may be forced to take bolder easing steps, although the weakening yuan is a constraint. Some strategists see an increasing chance that the yuan weakens past 7 to the dollar for the first time in more than a decade.

What Bloomberg’s Economists Say

“The policy focus should shift firmly back to cyclical stabilization to shield the economy from trade war pressure. President Donald Trump’s plan to put a 5% across-the-board tariff on Mexico suggests he’s ready to go all-in on trade -- a worrying sign for the U.S.-China trade war.”-- Chang Shu, and David Qu, Bloomberg Economics in Hong KongFor the full note click here

May was also a brutal month for stocks investors. The Shanghai Composite Index is on track for the worst May since 2011, slumping over 5% with foreigners fleeing at a record pace and mainland investors reluctant to buy the dip.

Trade tensions aren’t only rattling Chinese factories. The Nikkei Japan Purchasing Managers Index for manufacturers signaled a third contraction in factory activity this year in May, according to a preliminary reading last week. The euro zone is also headed for “lackluster” growth with its flash manufacturing PMI also trailing economist estimates.

China’s May deterioration was foreshadowed by Bloomberg’s deck of early indicators which showed weakness in stocks, copper prices and lower confidence among small firms

“The double dip risk is quite real,” said Lu Ting, chief China economist at Nomura Holdings Inc. in Hong Kong. “Downside pressures remain strong. Beijing cannot afford to stop easing.”

--With assistance from Yinan Zhao.

To contact Bloomberg News staff for this story: Xiaoqing Pi in Beijing at xpi1@bloomberg.net;Kevin Hamlin in Beijing at khamlin@bloomberg.net

To contact the editors responsible for this story: Jeffrey Black at jblack25@bloomberg.net, Sharon Chen

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