China’s inflation data for August shows that the country is slipping deeper into deflation. The Consumer Price Index (CPI) fell by 0.4% compared to last year, missing the expected decline of 0.2% and going down from the previous stable reading of 0.0%. The month-over-month CPI stayed the same, even though a 0.1% rise was anticipated after a 0.4% increase in July.

Producer Price Index and Involution

The Producer Price Index (PPI) dropped by 2.9% year-over-year, in line with expectations but better than the earlier 3.6% decline. Month-over-month, the PPI remained unchanged. Efforts to tackle involution, where too much competition stifles progress, are still struggling. This issue, especially evident in industries like solar, electric vehicles, and steel, is part of a policy shift started in July under President Xi Jinping’s leadership. The challenge is significant due to oversupply in competitive private industries. As China falls further into deflation, the August consumer price data of -0.4% confirms weak domestic demand. This trend continues despite the government’s stimulus efforts, which have not made a significant impact. For us, this strengthens a negative outlook on assets linked to Chinese consumption and the overall domestic economy. We expect the People’s Bank of China (PBOC) to implement more substantial easing, likely through additional rate cuts in the coming weeks. The PBOC has already lowered key lending rates several times in 2025, widening the gap with the U.S. Federal Reserve’s policies. This difference will continue to pressure the yuan, making it prudent to hold positions that benefit from a weaker currency, like buying USD/CNY call options. The PPI’s drop of 2.9% annually indicates that industrial overcapacity remains a significant problem. This is detrimental to global commodities reliant on Chinese industrial activity. We foresee ongoing weakness in iron ore, which has already dropped over 12% in the last quarter, and we are considering put options on copper and other base metals.

Market Implications and Comparisons

This economic weakness poses a major challenge for Chinese stock markets, making it sensible to buy puts on China-focused ETFs like the FXI. Growing uncertainty about future stimulus is increasing volatility; the Hang Seng implied volatility index is nearing its 12-month highs. In this climate, option strategies become more attractive as significant price fluctuations are expected. The current situation bears resemblance to Japan’s “lost decade” that began in the 1990s, marked by ongoing deflation and stagnant growth. If this trend persists, we could face an extended period of poor performance for Chinese equities. This long-term perspective supports strategies that profit from slow declines or sideways movement in the market over the coming months. Create your live VT Markets account and start trading now.

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