Why China's impressive rebound in industrial production could be short-lived

But there's some good news.

According to Bank of America Merrill Lynch, with a much stronger-than-expected 9.7% yoy industrial production growth (IP) in July (vs. 8.9% in June and consensus at 8.9%), strong import growth and a rebounding official PMI, prices of China related assets from commodities and commodity currencies to China's A/H shares have been rallying.

However, BofAML noted, "We do believe the impressive rebound in July will be short lived due to temporary pent-up demand and a structural downward growth trend, but the good news is that GDP growth in 2H will very likely be stable, meaning that Street GDP growth forecasts might be revised up in Aug and Sep."

Here's more from BofAML:

Since the outbreak of the interbank liquidity squeeze in June, markets finally breathed a sigh of relief. But what are investors thinking now?

Based on client requests we collected in the past few days, we summarize investor questions as follows: (1) Will the rebound in IP growth be sustainable or will it be short-lived?; (2) When will CPI inflation pick up?; and (3) What shall we expect from the coming 3rd Plenary Session of the Communist Party of China (CCP)? Answers to these questions have direct implications for investors in the near term.

A bright spot from August to mid-October 

 CPI inflation might stay below 3.0% in Aug and Sep despite the unusually hot weather. We think people will talk increasingly more about reform measures which will hopefully announced at the CCP's 3rd Plenary Session, and investors may rationally expect the Chinese government to deliver a stable financial and economic backdrop for the important Party conference in October.

With all these favorable factors, the economy and markets could be in a bright spot from August to Mid-October (when the 3rd Plenary Party Session likely starts).

After that, markets could see growth moderate, CPI inflation break the psychological 3.0% threshold, and the Party conference struggle to deliver an actionable reform plan. 

The growth rebound won't be "long-lived" for sure

Regarding why the rebound of IP growth could be short-lived, the ultimate answer is that China's growth is on a structural downward trend, so a cyclical rally could be quickly met with a structural force of slowdown.

Another factor could be that people just went too bearish in June due to the excessive anxiety in the interbank market (with IP growth dropping to 8.9% in June from 9.2% in May).

In July, with concerns relieved thanks to Premier Li's forceful intervention and an ensuing vow to deliver stable growth, there was a pent up demand for everything including inventory (which is the most sensitive part of aggregate demand) as confidence was regained. However, pent-up demand won't last long, in our view.