China is facing a prolonged price decline, raising concerns over a potential deflationary mindset. Policymakers are enhancing efforts to boost demand, but zero interest rates and QE remain off the table.
Upcoming high-level meetings suggest more actions to regulate disorderly competition with a focus on supply-side measures. It is anticipated that the Producer Price Index (PPI) could become positive within 6-12 months.
Falling Price Trends
The People’s Republic is observing declines in PPI since October 2022, while Consumer Price Index (CPI) inflation remains near zero. The trend of falling prices is encouraging consumers to delay spending and businesses to cut investments, dampening domestic demand.
With nominal GDP growth trailing real growth for nine straight quarters, the US-China GDP gap continues to widen. The Chinese government has adopted an expansionary budget and shifted to a ‘moderately loose’ monetary policy to counteract deflationary pressures.
Authorities are addressing over-supply through recent directives against ‘involution’ and unfair competition. Supply-side reforms aim to cut excess capacity, particularly in sectors dominated by private businesses like new energy vehicles. Market consolidation is anticipated to take some time.
We are looking at a market where falling prices are the main story, and this isn’t likely to change in the immediate future. This suggests a cautious approach, so we will consider buying put options on broad Chinese equity indices to protect against further downside. The current environment of weak consumer demand does not support aggressive bullish positions.
Strategic Market Moves
Looking at the latest data from July 2025 only confirms this view, with retail sales growth coming in at a sluggish 1.5% year-over-year. The Producer Price Index (PPI) did tick up slightly to -1.8%, but this still marks the 34th straight month of factory-gate deflation. These numbers tell us the pressure is still on, even if a bottom is forming.
The government’s plan to tackle oversupply rather than just flooding the market with stimulus is the key factor for us. We see this creating big winners and losers, especially in overcrowded sectors like electric vehicles. This is a clear signal to set up pair trades, buying calls on the likely survivors while buying puts on the weaker companies that may be forced to consolidate.
We are preparing for the expected PPI turnaround in the next six to twelve months, which would signal a major shift. This means we are starting to look at longer-dated call options on industrial and commodity-related stocks and ETFs. Recalling the supply-side reforms of 2016, we saw how a positive PPI flip triggered a strong rally in these exact sectors.
In the currency market, the central bank’s “moderately loose” policy will likely keep the yuan weak against the dollar. However, since policymakers are avoiding extreme measures like quantitative easing, we don’t expect a currency collapse. We will use options to trade a contained range in the USD/CNH pair, betting on continued but managed weakness.
