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China’s PMI contracts further, fuels expectations of government stimulus (Part 2)

Sr Emerging Markets Analyst

Continued from Part 1

After a third month falling below the 50 point neutral line, investors are starting to price in government intervention

The China Flash PMI for July disappointed investors in iShares FTSE/Xinhua China 25 (FXI) in a good way. Given the continued deterioration of conditions, the government will likely stimulate the economy to stay on top of the 7.5% GDP growth published for Q2. The indicator posted 47.7, which is the consecutive value below 50, implying contraction.

(Read more: Brazil’s Q2 starts stronger than expected, but can it keep it up until year end?)

Lower output

The output indicator dropped to 48.2 from 48.6 in June. The fact that output slowed was no surprise, given recent data on lower exports and slowdown in the industrial sector. The lower production aligned with faster destocking.

The finished goods inventory fell for the first time in five months, now below the neutral point with a 48.6.

Weaker demand

The new orders index dropped to 46.6 from 47.6 a month earlier, which means a faster decline. Again, this is in line with the slowing exports and lack of progress on conditions in Europe, which is a major export market. Weaker domestic demand was a main driver, likely fueled by the credit crunch experienced by small and medium businesses.

Read on for the key factors that may tip government action in Part 3.

(Read more: Why recession in Brazil is not imminent, but the short term will hurt)

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