China's Weak Factory Report Shows Need for Lasting Trade Truce

(Bloomberg) --

A gauge of activity in China's manufacturing sector showed the economy remains fragile, underlining the need for the truce with the U.S. forged at the weekend to be a lasting one.

China's manufacturing purchasing managers' index stayed at 49.4, according to official data released on Sunday. That's worse than the 49.5 forecast in a Bloomberg survey of economists. A sub-index gauging new export orders edged down further, highlighting the impact of previous tariffs. A reading below 50 signals contraction.

The weak result indicates that the recovery in the first half waned further, ahead of the truce reached at the weekend in Osaka between the U.S. and China that prevents further tariff increases for now. Similar manufacturing reports for the U.S. and the euro area due Monday are expected to show further reasons to worry about the global economy, which has suffered from the tariff uncertainty and a cyclical slowdown.

Read More: Trump Revives China Talks With Tariffs Truce, Break for Huawei

“As developments at the G-20 meeting have not removed the uncertainty created by trade tensions, we expect continued growth moderation in the second half despite more policy easing,” economists at Morgan Stanley including Cai Zhipeng wrote in a note.

Read More: Trump Revives China Talks With Tariffs Truce, Break for Huawei

After a high-stakes meeting with Chinese President Xi Jinping, Donald Trump said on Saturday that he would hold off imposing higher tariffs on $300 billion of imports from China and the world's two largest economies agreed to resume negotiations. Trump also said he would delay restrictions against Huawei Technologies Co., China's largest telecommunications equipment maker.

What Bloomberg's Economists Say

“The latest truce in the trade war should help improve market and business sentiment to some extent. Even so, reaching a final deal is far from certain. And the existing 25% tariffs on half of Chinese exports to the U.S. are a heavy burden on the export sector.”
-- Chang Shu, Chief Asia Economist, Bloomberg Economics
For the full note click here

More manufacturing data from China, including the Caixin manufacturing PMI to be released on Monday, will offer additional insight on how the economy has fared in June. Readings from the major economies all flashed warning signs -- a preliminary gauge from the U.S. fell to the lowest since last 2009 in June, that of the euro zone remained in contraction, while the gauge for Japan also indicated deterioration.

On the ground, smaller exporters in China's manufacturing heartland told Bloomberg in June that the broader economic uncertainty, and not just Trump's tariffs, is what's inflicting the pain on them.

Read More: Chinese Exporters' Pain Is Caused by More Than U.S. Tariffs

“China's slowdown now right now is only partly due to the trade war,” said Larry Hu, chief China economist at Macquarie Group Ltd. in Hong Kong. “The global slowdown and domestic loss of momentum are the more important factors. China's economy will not bottom out until the government rolls out more aggressive policy measures, ” he said, which would include boosting infrastructure investment funding, property investment and consumption.

The non-manufacturing gauge, which covers both services and construction, edged down to 54.2 from 54.3 in May, still firmly in the expansion zone. A pick-up in the new orders for construction activity suggested the government's support on infrastructure has risen, according to Bloomberg Economics.

What's more worrying is the worsening jobs market: the employment sub-index of the manufacturing sector fell further to the lowest level since 2009 and that of the non-manufacturing dropped to the worst since early 2016.

The slowdown is hurting smaller factories most, while larger ones are not prospering either. An index for large manufacturing companies dropped to the contraction zone for the first time in more than three years. A collection of early data by Bloomberg also showed the economy worsening in June, with poor small business confidence and weak trade.

“The second quarter will be the lowest point of China's economy this year,” said Lu Zhengwei, chief economist at Industrial Bank Co in Shanghai. Stimulus policies “are cushioning impacts from the trade tensions. If China and U.S. reach a deal this year, policy will no longer be as supportive. If they don't, policy will be more aggressive. ”

--With assistance from James Mayger.

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

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

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With assistance from Bloomberg