Category: GDP and Activity

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Prepare for China Shock 2.0 and its Gold Impact

Key Points

  • China’s first deflationary shock flooded the global economy with cheap labor in the early 2000s and hollowed out low-tech manufacturing industry in developed economies.
  • A credit-fueled boom followed, with huge investment in infrastructure and real estate to sustain economic growth.
  • A massive speculative real estate bubble developed, forcing Beijing to intervene.
  • The real estate bubble collapsed in a controlled implosion after banking regulators restricted credit to the sector.
  • Plunging real estate prices destroyed household wealth, setting off a deflationary spiral in China’s domestic economy.
  • The government channeled investment into high-tech manufacturing to offset collapsing demand.
  • Weak local demand forced manufacturers to focus on export markets.
  • Booming Chinese exports of electric vehicles and other high-tech products threaten to hollow out high-tech industries in developed economies.
  • However, export markets aren’t large enough to absorb China’s demand shock, and pushback from trading partners will likely trigger a major contraction.

Last week we focused on the slowdown of China’s economy. This week, we examine the root cause of the problem. Credit.

China experienced a credit-fueled boom in the early 2000s. This went into overdrive with massive government stimulus during the 2008 global financial crisis.

Unrestrained lending led to a massive speculative bubble in the real estate sector. Alarmed by the rate of credit expansion, Beijing put the brakes on, restricting sector access to credit in 2022.

The collapsing real estate bubble has destroyed household wealth.

China: House Price Index

Consumer Confidence collapsed in 2022 and has not recovered.

China: Consumer Confidence

Household Debt, which had grown rapidly as a percentage of GDP, plateaued until 2024, and has now started to decline.

China: Household Debt Percentage of GDP

Property Investment has contracted since 2022, and is now shrinking at an annual rate of 18%.

China: Property Investment

Loan growth from financial institutions has rapidly decelerated to a low of 5.2% in June 2026.

China: Outstanding Loan Growth

Credit is the lifeblood of an economy, and rapid deceleration in credit growth triggers a domino effect of demand contraction across the economy.

Manufacturers turned to export markets to offset declining domestic demand, with exports peaking at $412 billion in June 2026.

China: Exports

China’s trade surplus jumped to $126 billion in June, falling back to $113 billion in July.

China: Trade Surplus

The People’s Bank of China (PBOC) has steadily expanded its balance sheet, employing QE to suppress long-term interest rates and stimulate the economy.

China: PBOC Balance Sheet

The Chinese government is also running deficits to support the economy, with government debt rapidly expanding to 99.2% of GDP in 2025.

China: Government Debt to GDP

Overall debt in the economy shows a similarly steep growth path despite slowing household credit growth.

China: Government Debt to GDP

Developed economies are not much better off (below), with average total debt at 260% of GDP and government debt at 100% of GDP. However, the difference lies in the growth rate: developed economies are no higher than in 2010, while China has almost doubled.

Developed Markets: Government Debt to GDP

Conclusion

China has enjoyed a debt-fueled boom for more than 20 years, but is now sliding into a deflationary contraction. The Chinese economy is addicted to credit, and regulators’ attempts to rein in the speculative real estate boom have triggered a deflationary spiral. Falling real estate prices have destroyed household wealth, leading to a contraction in domestic demand. Beijing boosted investment in high-tech industry to sustain economic growth, leading to a massive trade surplus as manufacturers turned to export markets to offset shrinking domestic demand.

However, export markets are not large enough to absorb China’s deflationary surge without themselves suffering a domestic contraction. We expect trade surpluses to fall as trading partners push back with tariffs, import quotas, and other trade barriers.

China will then face a stark choice between a collapsing economy and debasing the Yuan through high inflation. We believe that Beijing has chosen the latter option, as the lesser of two evils, and will rapidly expand credit in the economy to that end while the PBOC expands its balance sheet to suppress long-term interest rates.

China’s debasement of the Yuan has fueled a rapid growth in domestic demand for Gold as a store of value, leading to a close correlation between Gold and the PBOC’s balance sheet.

China: PBOC Balance Sheet

Acknowledgments

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Weak Dollar Boosts Gold & Copper

Key Points

  • Gold is testing resistance at $4,250 per ounce.
  • Copper (COMEX September futures) jumped to $6.72/lb.
  • US Treasury intervention in the Japanese Yen has rattled bond market investors.
  • The ISM Services PMI signals expansion, but signals weak job growth and strong inflationary pressures.

Gold rallied to test resistance at $4,250 per ounce. A breakout would signal another test of $5,000.

Spot Gold

Copper jumped to $6.72/lb on the COMEX futures exchange (Sep’26), continuing its long-term uptrend.

CNBC: Copper

The Dollar softened after last week’s joint intervention by Japan’s Ministry of Finance (MoF) and the US Treasury to support the Yen. Bond market traders are questioning why the US Treasury was involved and not the G7. Coordinated action by G7 central banks has supported past interventions. This time, the G7 were not involved, and the conclusion is that the US Treasury was acting to protect its Treasury market. The US Treasury repo operations circumvented the MoF being forced to sell US Treasuries to support the Yen, a move that would have driven up yields. (Reuters)

Dollar Index

Stocks & Financial Markets

Bitcoin1 continues to consolidate in a narrow range above 60000, a bearish sign in a downtrend. A breakout above 65000 would signal that financial market risk aversion is easing, while a break below 60000 would warn of a major liquidity contraction.

Bitcoin (BTC)

Dow Jones Industrial Average broke out above 53000, and is headed for a test of 55000. Trend Index troughs above the zero line confirm buying pressure.

Dow Jones Industrial Average

ISM Services

The ISM Services PMI increased to 54.1% for July, signaling a broad economic expansion.

ISM Services PMI

However, the Employment index fell to 47.4%, warning of weak job growth ahead.

ISM Services Employment

Services Prices also increased to 70.3%, a level similar to Manufacturing, signaling strong inflationary pressures.

ISM Services Prices

Conclusion

US Treasury operations to assist Japan’s intervention in support of the Yen underscore the fragility of US Treasury markets. The move fueled a rally in Gold and Copper, as well as the Dow, as confidence in US Treasury markets was shaken.

The ISM Services PMI signals continued expansion, but warns of weak job growth and strong inflationary pressures.

Acknowledgments

Notes

  1. Cryptocurrencies are the highest-risk asset class, and we analyze Bitcoin (BTC) solely to identify risk sentiment in financial markets. Our analysis is not a recommendation to buy or sell BTC, nor is it a commentary on the merits of cryptocurrency.
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4 Key Takeaways for the Week

Key Points

  • Long-term Treasury yields climbed after the Fed kept rates unchanged.
  • The Japanese Yen is weakening as the Bank of Japan slow walks rate hikes.
  • Gold absorbs selling pressure as long-term rates rise.
  • China’s economy is slowing.

Treasury Market

The bond market has been anticipating a rate hike. This has been signaled since the 2-year Treasury yield broke above the Fed funds target range in March 2026.

2-Year Treasury Yield & Fed Funds Target (Upper Limit)

The FOMC voted to keep the Fed funds rate unchanged, with a target range of 3.5% to 3.75%. There were 3 dissenting votes, calling for a rate hike. The new Fed Chair, Kevin Warsh, is encouraging opposing views, and we can expect more dissent in the future. Warsh has also avoided forward guidance, which is likely to increase volatility in the bond market and consequently the term premium.

10-year Treasury yields climbed to 4.745% on Friday, reflecting market concern that the FOMC is not taking a more hawkish stance on inflation.

10-Year Treasury Yield

GDP grew at 6.5% over the 12 months to June, suggesting that the 10-year yield needs to rise by at least 175 basis points if the Fed is serious about containing inflation. Long-term interest rates below nominal GDP growth (the rate of return on new capital investment) encourage rapid credit growth, with demand expanding faster than output.

10-Year Treasury Yield & Nominal GDP Growth

Japan & the Sovereign Bond Market

Japan’s GDP grew by 3.6% over the 12 months to March 2026. The 10-year JGB yield is 2.8%, indicating that monetary policy remains stimulative, but less so than the US.

10-Year Treasury Yield & Nominal GDP Growth

The Bank of Japan kept its policy rate at 1.0% at last week’s meeting despite an upturn in CPI to 1.7%. The weakening Yen drives higher inflation.

Japanese CPI Inflation

The low BOJ policy rate and ongoing bond purchases aimed at suppressing long-term JGB yields undermine the currency. The Yen has steadily weakened, breaking above 160 against the Dollar in June 2026 to reach its highest level in 39 years. Japan’s Ministry of Finance intervened on Thursday to support the Yen, driving the exchange rate to 157 against the Dollar. However, the effect of these MoF interventions is short-lived because of BoJ policy.

Japanese Yen

Rising long-term yields in sovereign bond markets reflect growing concern over sovereign debt levels and the risk of fiscal dominance. When central bank policy is dominated by government bond markets’ need for support, with lower interest rates prioritized above containing inflation, the currency’s purchasing power is eroded, as in Japan.

The US 30-year Treasury yield has climbed to 5.275%, reflecting concerns over currency debasement.

30-Year Treasury Yield

The Japanese JGB yield is lower at 3.98%, but this reflects sizable ongoing QE by the Bank of Japan aimed at suppressing long-term rates.

30-Year JGB Yield

The Bank of Japan has higher debt levels relative to GDP than the UK and should theoretically trade at a higher yield. The difference in the 30-year Gilt yield lies in central bank monetary policy: the Bank of England is steadily shrinking its balance sheet, while the BoJ is actively buying JGBs in the secondary market to suppress yields.

30-Year UK Gilts Yield

Dollar & Gold

Rising short-term yields are strengthening the Dollar, with the 1-Year Treasury yield gaining more than 50 basis points in the last 6 months.

1-Year Treasury Yield (CNBC)

Gold has softened considerably from its peak of $5,500 per ounce and has been testing primary support at $4,000 over the past 8 weeks.

Spot Gold

Gold ETF inflows slowed in the first half of 2026 but remained positive, driven by continued inflows into Asian funds. North America experienced an outflow of $7.7 billion, European inflows slowed to $3.2 billion, while Asia recorded a strong inflow of $12 billion.

Gold ETF Flows

Average daily trading volumes surged to a record $488 billion in the first half of 2026.

Gold Average Daily Trading Volumes

OTC trading, led by the LBMA, averaged US$249bn/day, substantially above 2025 levels and underscoring the depth of institutional participation. Exchange-traded volumes also jumped, reaching US$227bn/day – 22% higher than the 2025 average – supported by elevated investor activity. Meanwhile, global Gold ETF trading averaged US$12bn/day – up 73% from 2025 – fueled primarily by robust trading in US funds as investors increasingly turned to Gold amid heightened macroeconomic and geopolitical uncertainty.

Comex futures net longs increased to 538 tonnes, up 16% since May, and the highest month-end level since January despite a weakening gold price. A closer look shows retail participation (non-reportable net longs declined in June, while other reportables, which capture large trades outside the managed money category, were up 16% from May. Managed money net longs remained broadly stable, declining by just 43 tonnes year-to-date. Again, H1 investor behavior differed: retail positioning largely tracked short-term price movements while larger traders’ positions have, in general, stayed stable since mid-March. (WGC)

Comex contracts standing for delivery jumped to 13,123 in July from 8,838 in May, and a 9.0% increase over July last year.

Spot Gold

China

The Chinese NBS Manufacturing PMI fell to 49.2 in July, down sharply from 50.3 in June. Values below 50 indicate a contraction in the manufacturing sector.

China: NBS Manufacturing PMI

The OECD Composite Leading Indicator for China fell to 98.6 in June, below its long-term average of 100, signaling a contraction.

OECD: China Composite Leading Indicator

The RBA’s activity indicators for China show industrial production is holding up, boosted by record exports. However, real retail sales growth has stalled, while fixed asset investment has contracted sharply following Trump’s tariff blitz last year.

OECD: China Activity Indicators

Household credit growth (purple below) has also stalled. Business credit has taken up the slack, but government credit growth is also contracting.

OECD: China Total Social Financing

Conclusion

10-year US Treasury yields jumped to 4.745% after the Fed kept its funds target range at 3.5%-3.75%, reflecting bond market concerns over inflation.

The new Fed Chair’s strategy is to keep short-term rates low and allow long-term rates to rise, to slow the rate of demand growth in the economy and curb inflation. However, nominal GDP is growing at an annual rate of 6.5%, which means that 10-year Treasury yields would need to rise by 175 basis points to keep inflation in check. An increase to 6.5% would likely cause a sharp contraction in stocks.

Japan’s Ministry of Finance has intervened to support the Yen. However, the effects will likely be short-lived, as the Bank of Japan continues to maintain stimulative monetary policy, which fuels inflation and undermines the currency.

Rising long-term sovereign debt yields reflect bond market concerns over rising sovereign debt and the risk of fiscal dominance, as in Japan, where the central bank has prioritized maintaining an orderly bond market above price stability. Erosion of the currency purchasing power is the inevitable outcome.

Gold has found strong support at $4,000 per ounce, with long-term investors prepared to wait out the turmoil in the Middle East. Demand from Asian investors has been particularly strong, but could be undermined if China goes into recession.

China’s economy shows increasing signs of contraction, precipitated by a decline in business investment following President Trump’s 2025 tariff attack. Household credit and real retail sales have stalled, and the NBS Manufacturing PMI fell to 49.2, signaling a contraction. Higher fuel prices would be an added headwind that could tip the economy into recession.

Acknowledgments

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Bank of Japan a Leading Indicator?

Bank of Japan

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PPI Shock But Optimism Over Rate Cut Grows

Key Points

  • The Producer Price Index (PPI) grew by 1.06% in May, for the second straight month, at an annualized rate of 12.7%.
  • Annual PPI growth rose to 6.4%.
  • Bank credit growing faster than real GDP reflects rising inflationary pressure.
  • Bitcoin continues to test support at 60,000, signaling risk-off across financial markets.
  • Stocks and Gold are rising as optimism over a peace deal grows.

The monthly Producer Price Index (PPI) grew 1.06% in May, matching the April figure, with an annualized rate of 12.7%.

Producer Price Index (PPI) - Monthly

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Markets in Risk-Off Despite High Stock Prices

Key Points

  • Bitcoin tests support at 70,000, signaling risk-off.
  • Stocks continue their uptrend.
  • Consumers continue to spend, but the falling saving rate suggests they are under pressure.
  • Manufacturers are building inventories ahead of expected price rises and supply chain disruptions.

Bitcoin1 is testing support at 70,000. The steep downtrend warns that financial markets are increasingly risk-averse.

Bitcoin (BTC)

However, indices like the NASDAQ remain in a strong uptrend, with the Invesco QQQ ETF close to our target of 750.

Invesco Nasdaq 100 ETF (QQQ)

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There is No Deal

Key Points

  • President Trump raised hopes that he is about to sign a deal with Iran that will allow shipping through the Strait of Hormuz.
  • Crude prices fell, along with long-term Treasury yields.
  • The US economy is slowing, with real GDP growth at an annualized rate of 1.6% in the first quarter.
  • Real personal income per capita declined for the third straight month.
  • Personal savings plunged, warning of a recession.

Brent crude is testing support at $90 per barrel on news of an “imminent deal” with Iran.

Brent Crude

Every time the 10-year Treasury yield reaches 4.5%, Axios runs a headline citing sources close to the President saying he is close to a deal. Crude oil futures plunge, but the deal never materializes.

WASHINGTON/CAIRO, May 28 (Reuters) – The United States and Iran reached ​an agreement on Thursday to extend their ceasefire and lift restrictions on shipping through the Strait of Hormuz, sources told Reuters, though U.S. President Donald Trump has yet to approve ‌it and Iranian state media said it had not been finalized.

According to four sources familiar with the matter, the agreement would extend the truce for another 60 days and allow traffic to flow through the strategic waterway while negotiators tackle difficult issues such as Iran’s nuclear program.

Trump has not yet approved the deal, the sources said. Iran has yet to comment on news of the proposed ​deal, which was first reported by Axios.

Ignore the BS and focus on the bottom line. There is no deal until an agreement is signed — and adhered to by all parties, including Bibi Netanyahu.

US Strategic Petroleum Reserves fell by another 9 million barrels in the week ending May 22.

EIA Strategic Petroleum Reserves (SPR)

If the Strait of Hormuz remains closed at the end of June, crude oil markets will panic over looming shortages.
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Bipolar Disorder

Key Points

  • The University of Michigan Consumer Sentiment Index fell to a new record low since the series started in 1960.
  • The Dow Jones Industrial Average broke through resistance at 50,000, confirming a fresh bull market advance.

The University of Michigan Consumer Sentiment Index fell to a new low of 44.8.

University of Michigan: Consumer Sentiment

A plot of the 3-month moving average since 1960, when the Consumer Sentiment series started, shows that consumer sentiment is at a record low.

University of Michigan: Consumer Sentiment

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S&P 500 Rallies on Job Gains, But Peace Deal Hopes Crash

Key Points

  • President Trump rejects Iran’s peace proposal.
  • Iran continued attacks on its Gulf neighbors.
  • Brent crude July futures jump to $104.50 per barrel.
  • Confidential intelligence sources say that Iran can survive a US blockade for at least 3-4 months.
  • The US labor market added 115,000 jobs in April 2026, while unemployment held steady at 4.3%.
  • The S&P 500 reached a new high, while the Dow Jones Industrial Average threatens a breakout.

DUBAI/WASHINGTON, May 10 (Reuters) – President Donald Trump on Sunday rejected Iran’s response to a US proposal for peace talks, dashing hopes for an imminent end to the 10-week-old conflict….

“I don’t like it — TOTALLY UNACCEPTABLE,” Trump wrote on Truth Social, without giving further detail. Oil prices rose $3 a barrel after the United States and Iran failed to reach agreement.

Iran’s proposal includes a demand for compensation for war damages and an ​emphasis on Iranian sovereignty over the strait, state media said. It also calls on the US to end its naval blockade, guarantee no further attacks, lift sanctions and end a US ban on Iranian oil ​sales, the semi-official Tasnim news agency said.

Brent Crude July’26 (Nymex) futures jumped to $104.50 per barrel while December’26 futures (orange) rallied to $89.25 per barrel. December prices reflect the oil market’s longer-term assessment of crude shortages. Damage to existing production and shipping facilities will take time to repair, even if the Strait of Hormuz is reopened.

Brent Crude Nymex Futures (July'26 & Dec'26)

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Trump Talks “Peace Deal” But Nothing Stops This Train

Key Points

  • President Trump again baits financial markets with the prospect of a peace agreement.
  • Brent Crude (July’26 futures) is testing support at $100 per barrel.
  • However, the crude market faces critical shortages even if a peace deal is signed.
  • The S&P 500 rallied to a new high at 7365, while the Dow threatens a breakout above 50,000.
  • The ISM Services PMI warns that growth is slowing, while soaring prices signal inflationary pressures.
  • Lithium is in a strong uptrend, while Copper, Critical Materials, and Uranium show signs of a recovery.
  • The RBA hiked rates this week and would like to hold for a while, but rising prices may force further hikes.

ISLAMABAD/WASHINGTON/TEL AVIV, May 7 (Reuters) – U.S. President Donald Trump predicted a swift end to the ​war with Iran as Tehran considered a U.S. peace proposal that sources said would formally end the conflict while leaving unresolved key U.S. demands that Iran suspend ‌its nuclear program and reopen the Strait of Hormuz.

An Iranian foreign ministry spokesperson cited by Iran’s ISNA news agency said Tehran would convey its response, while Iranian lawmaker Ebrahim Rezaei, a spokesperson for parliament’s powerful foreign policy and national security committee, described the proposal as “more of an American wish-list than a reality.”

“They want to make a deal. We’ve had very good talks over the last 24 hours, and it’s very possible that we’ll make ​a deal,” Trump told reporters in the Oval Office on Wednesday, saying later “it’ll be over quickly.”

Trump has repeatedly played up the prospect of an agreement to end the war ​that started on February 28, so far without success. The two sides remain at odds over a variety of difficult issues, such as Iran’s nuclear ⁠ambitions and its control of the Strait of Hormuz, which before the war handled one-fifth of the world’s oil and gas supply.

A Pakistani source and another source briefed on the mediation ​said an agreement was close on a one-page memorandum that would formally end the conflict. That would kick off discussions to unblock shipping through the strait, lift U.S. sanctions on Iran and set ​curbs on Iran’s nuclear program, the sources said.

A separate senior Pakistani official involved in the talks told Reuters on Thursday that negotiators were hopeful of reaching a deal but noted gaps between the sides remained.

Brent Crude (July futures), buoyed by optimism over a prospective peace deal, is retracing to test support at $100 per barrel.

Brent Crude Futures (ICE July'26)

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