China Services Activity Hits 7-Month High, but US Trade Fears Dent Optimism, Caixin PMI Shows

China's services sector expanded at its fastest pace in seven months in December, driven by a surge in domestic demand, according to the Caixin/S&P Global services purchasing managers' index (PMI). The PMI rose to 52.2 from 51.5 in November, surpassing the 50-mark that separates expansion from contraction. However, market sentiment weakened to the lowest since March 2020, amid concerns about downward pressure on the economy and rising competition.

The services sector's expansion was supported by a strong increase in new business, with the new business sub-index rising to 52.7 from 51.8 in November. This was the highest reading since May 2024 and marked the 18th straight month of growth in services activity. However, new export orders fell for the first time since August 2023, indicating a slowdown in foreign demand for Chinese services.

Employment in the services sector fell marginally in December, amid resignations and redundancies. This was the first decline in four months and pushed increased backlogs of work for the first time in five months. The decline in employment was accompanied by a slight increase in prices, with input cost inflation accelerating to an 11-month high. As a result, output cost inflation rose to the highest since January 2022, as firms shared their increased cost burdens with clients.

The Caixin China General Services PMI data suggests that the Chinese services sector is benefiting from strong domestic demand, but concerns about the global economic outlook and US-China trade tensions are weighing on market sentiment. The US-China trade war, launched by the US in 2018, has disrupted global supply chains and reshaped economic interdependence. This has led to a decline in the US's share in China's exports and China's share in US imports, indicating a derisking trend that has persisted since 2018.

The US-China trade tensions have also affected specific industries within China. For example, products such as furniture, toys, sports requisites, footwear, and headwear are trade goods that China and the US rely on each other for the most. These types of products could not only hurt China's exports but also cause potential reinflation in the US if tariffs are imposed. The US would need to source these products elsewhere or produce them domestically, which can be more costly.

The trade tensions have also led to a decline in foreign orders for Chinese services. In December 2024, the Caixin China General Services PMI showed that new export orders fell for the first time since August 2023, indicating a slowdown in foreign demand for Chinese services. This decline in foreign orders, coupled with the decline in employment, suggests that the Chinese services sector may face headwinds in the coming months.

In conclusion, the Chinese services sector is benefiting from strong domestic demand, but concerns about the global economic outlook and US-China trade tensions are weighing on market sentiment. The trade tensions have disrupted supply chains, affected specific industries, and led to a decline in foreign orders and employment in the Chinese services sector. To mitigate the impact of US-China trade tensions, Chinese services firms can consider diversifying export markets, shifting production to other countries, investing in domestic market, adopting technology and automation, strengthening supply chain resilience, and promoting regional economic integration.