China's May factory activity unexpectedly shrinks, clocking its worst drop since 2022: Caixin

China's manufacturing sector contracted in May at the fastest rate since September 2022, with the Caixin/S&P Global PMI falling to 48.3, signaling a decline in new export orders and reinforcing calls for increased stimulus. This private survey aligns with official data indicating a second month of contraction, despite some signs of stabilization. These figures, coupled with persistent deflationary pressures and a struggling property market, come as policymakers implement measures to stimulate consumption and support businesses amidst existing tariffs and economic headwinds.

Analysis

China's manufacturing sector displayed notable weakness in May, as evidenced by the Caixin/S&P Global manufacturing purchasing managers' index dropping to 48.3, its most significant contraction since September 2022 and well below the Reuters median estimate of 50.6. This private survey, focusing on over 500 mostly export-oriented firms, indicated an accelerated decline in new export orders, reinforcing calls for stronger stimulus. This aligns with the official PMI, which, despite ticking slightly higher to 49.5 from 49.0 in April, remained in contraction for a second consecutive month. The broader economic landscape shows mixed signals but leans towards caution: industrial output growth slowed to 6.1% year-on-year in April from 7.7% the previous month, and retail sales grew a less-than-expected 5.1%. Persistent deflationary pressures are a key concern, with wholesale prices posting their steepest drop in six months in April and consumer prices falling for a third consecutive month. The property sector continues to struggle, with property-related investment declining 10.3% year-on-year for the January to April period. Despite these headwinds and U.S. tariffs on Chinese imports averaging 51.1% (though some new tariffs are paused), April exports rose a better-than-expected 8.1% year-on-year, and industrial profits increased for a second month. In response to economic challenges, the People's Bank of China reduced key policy rates by 10 basis points and the reserve requirement ratio by 50 basis points in May to bolster liquidity.

Key Decisions for Investors

• Investors should closely monitor the efficacy of recent monetary easing, including the 10 basis point policy rate cut and 50 basis point RRR cut in May, and anticipate potential further stimulus measures from Beijing given the contracting Caixin PMI of 48.3 and persistent deflationary pressures.
• Exercise caution regarding exposures to sectors reliant on Chinese domestic demand, such as retail and property, considering that April retail sales rose only 5.1% missing expectations, consumer prices fell for a third month, and property-related investment declined 10.3% year-on-year through April.
• Evaluate the sustainability of April's 8.1% export growth, especially for export-oriented firms, in light of the Caixin survey's report of quickening declines in new export orders for May and the prevailing tariff environment, despite a temporary pause on certain U.S. tariffs.