China is experiencing a long-term drop in prices, raising worries about deflation. Policymakers are working hard to increase demand, but low interest rates and quantitative easing are not on the table. Upcoming high-level meetings may lead to actions aimed at controlling unhealthy competition, focusing on supply-side measures. Experts believe the Producer Price Index (PPI) could recover to positive levels in the next 6 to 12 months. Since October 2022, the PPI has been declining, while the Consumer Price Index (CPI) inflation hovers around zero. As prices fall, consumers are putting off purchases, and businesses are reducing investments, which harms domestic demand. For nine consecutive quarters, nominal GDP growth has lagged behind real growth, widening the GDP gap between the US and China. To tackle deflation, the Chinese government has implemented a more expansive budget and a “moderately loose” monetary policy. Recent measures have focused on reducing over-supply and addressing unfair competition. Supply-side reforms aim to lower excess capacity, especially in sectors where private firms dominate, such as new energy vehicles. However, it may take time for market consolidation to occur. Right now, the main story is falling prices, and this trend is unlikely to change soon. This calls for caution, leading us to consider buying put options on broad Chinese equity indices for protection against further declines. The weak consumer demand does not support aggressive buying strategies. Data from July 2025 supports this perspective, showing retail sales growth at a sluggish 1.5% year-over-year. Although the Producer Price Index (PPI) slightly increased to -1.8%, it still marks the 34th consecutive month of factory-gate deflation. These figures prove that the pressure remains, even if a bottom is approaching. The government’s focus on managing oversupply rather than just flooding the market with stimulus is crucial. This could lead to big winners and losers, particularly in crowded sectors like electric vehicles. It’s a strong signal for pair trades—buying calls on likely survivors while buying puts on weaker companies that may need to consolidate. We are preparing for a potential turnaround in the PPI within the next six to twelve months, which could indicate a significant shift. This has prompted us to start considering longer-dated call options on industrial and commodity-related stocks and ETFs. Similar to the supply-side reforms of 2016, a positive PPI shift could lead to a strong rally in these sectors. In the currency market, the central bank’s “moderately loose” policy is likely to keep the yuan weak against the dollar. However, because policymakers are avoiding drastic measures like quantitative easing, a currency collapse is not expected. We plan to use options to trade within a limited range in the USD/CNH pair, betting on continued but controlled weakness.

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