China free liquidity has fallen to a new low since May 2025, but is expected to gradually improve before year-end

Overview

This report focuses on the relationship between China's free liquidity indicator and the year-over-year change in MSCI China. The core judgment is that free liquidity has fallen to a new low since May 2025, mainly due to weak M1 growth, still-high PPI, and strong industrial output; however, as June may mark the cyclical peak in PPI growth and in-budget bond issuance accelerates in 2H26, liquidity is expected to gradually improve by year-end.

Core views

The core view of the report is "improving from low levels but still tight." On the one hand, free liquidity is currently at a cyclical low, constraining the Chinese equity market; on the other hand, easing inflation pressure and faster fiscal bond issuance may drive marginal improvement in liquidity. The limiting factor is that corporate borrowing appetite remains weak, indicating that macro credit transmission has not yet clearly recovered.

Analysis framework

The report uses a macro liquidity tracking framework, combining variables such as M1, PPI, and industrial output, and compares them with MSCI China year-over-year performance to assess the potential impact of the liquidity environment on Chinese equity assets. Industrial output year-over-year is measured using a 3-month moving average, and the trend lines in the chart use Morgan Stanley economists' quarterly estimates for 2Q26, 3Q26, and 4Q26.

Methodology notes

• Macro liquidityMS China Free Liquidity Indicator

  China free liquidity indicator

  This indicator is used to observe changes in available liquidity under the combined effects of money growth, price pressure, and real production activity; the report notes that its recent decline was jointly driven by weak M1 growth, elevated PPI, and strong industrial output.

• Market comparisonMSCI China YoY Change

  MSCI China year-over-year change

  The report compares the free liquidity indicator with MSCI China year-over-year performance to judge the relationship between changes in macro liquidity and the performance of the Chinese equity market.

• Smoothing treatment3-month moving average

  3-month moving average of industrial output year-over-year

  The report uses a 3-month moving average for industrial output year-over-year to reduce the disturbance of single-month volatility on observations of free liquidity.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• MSCI China

  Serves as the main observation target for Chinese equity market performance and is compared against year-over-year changes in free liquidity.

  Strengths

  If PPI declines and in-budget bond issuance accelerates to improve liquidity, MSCI China may benefit from marginal recovery in macro liquidity.

  Weaknesses

  Current free liquidity is at its lowest level since May 2025, and corporate borrowing appetite is weak, indicating ongoing constraints from fundamentals and credit transmission.

  Comparison

  The report focuses on the leading or synchronous relationship between the free liquidity indicator and MSCI China year-over-year change, rather than comparing single companies or industries.

  Risks

  If PPI does not peak as expected, fiscal issuance progresses more slowly than expected, or corporate financing demand remains weak, liquidity recovery may be insufficient.

• Chinese equities

  Macro liquidity is an important variable affecting risk appetite and the valuation environment for Chinese equities.

  Strengths

  Gradual improvement in liquidity before year-end may support market risk appetite.

  Weaknesses

  The macro backdrop remains challenging, and moderate corporate borrowing appetite limits the transmission of credit expansion to the stock market.

  Comparison

  Compared with simply observing price or earnings indicators, this report places greater emphasis on the liquidity environment jointly shaped by money, inflation, and industrial activity.

  Risks

  The market may price in expectations of liquidity improvement ahead of time, while the actual pace of macro recovery remains uncertain.

Key data

• Free liquidity statusFell to a new low since May 2025The report says the decline was driven by weak M1 growth, elevated PPI, and strong industrial output.
• Liquidity outlookExpected to gradually improve before year-endThe main basis is that June may be the cyclical peak of PPI growth, along with faster in-budget bond issuance in 2H26.
• Overall judgmentLikely to remain relatively tightCorporate borrowing appetite remains subdued under a challenging macro backdrop, limiting the extent of liquidity recovery.
• Subject of analysisMS China Free Liquidity Indicator vs. MSCI China YoY ChangeUsed to observe the relationship between China's free liquidity and MSCI China year-over-year performance.
• Morgan Stanley global equity rating distributionOverweight/Buy 1,544 stocks, accounting for 42%; Equal-weight/Hold 1,577 stocks, accounting for 43%; Underweight/Sell 544 stocks, accounting for 15%This data is for disclosure purposes as of June 30, 2026, and does not constitute the report's direct rating conclusion on the China market.

Impact & implications

For investors, improvement in liquidity from low levels may help ease macro pressure on the Chinese equity market, but the judgment that conditions are "still tight" means market resilience may depend on further PPI declines, implementation of fiscal bond issuance, and recovery in corporate financing demand. If free liquidity improves less than expected, the year-over-year performance of MSCI China-related assets may remain under pressure.

Risks

• PPI growth may not peak in June as expected, delaying improvement in free liquidity.
• Acceleration in 2H26 in-budget bond issuance may fall short of expectations, leaving fiscal liquidity support weaker than assumed in the report.
• Corporate borrowing appetite may remain weak, making it difficult for liquidity improvement to translate into credit expansion and the equity market.
• A continued challenging macro backdrop may suppress risk appetite for Chinese equity assets.
• The report does not provide a single-company rating or target price and therefore cannot directly replace stock-specific investment judgment.

What to watch

• Whether M1 growth rebounds going forward.
• Whether PPI growth declines from its June peak.
• Changes in industrial output growth and its 3-month moving average.
• The pace and scale of 2H26 in-budget bond issuance.
• Whether corporate borrowing demand improves.
• Whether MSCI China year-over-year performance follows the marginal recovery in free liquidity.