The
Fed's 50 bp rate hike is behind us. Another 50 bp hike is expected next
month. The April
employment report will do little to calm the anxiety about the "too
tight" labor market. The decline in the participation rate was disappointing and this coupled with decline in Q1 productivity raies questions about the economy's non-inflationary speed limit.
One of the fascinating
things about the markets is that sometimes the cause take place after the
effect. This is an
interesting way to express the observation that investors anticipate, discount,
futures scenarios. The dollar has been bought and fixed income sold on
ideas that the Fed had taken a hawkish turn. The market now accepts that
the Federal Reserve will bring it Fed funds target rate within the range
regarded as neutral before the end of the year. The hikes will be
front-loaded with the next 50 bp hikes discounted for the next two meetings
(June and July) and a strong leaning for the same in September (~66%). The
balance sheet will begin shrinking next month at roughly the same pace that it
peaked in the 2017-2019 experience before ramping up to twice the pace ($95
bln).
The week ahead is important
because it may be the first signs that may be peak inflation is at hand. For the first time since April 2020,
the headline reading of consumer prices and producer prices are expected to
have fallen on a year-over-year basis. To be sure, it may not be a large
move. By any measure price pressures remain elevated, but the direction
is important.
It would be the first
decline in headline CPI since last August. Core CPI will also likely ease as
well. Recall that after the March report, many economists suggested that
could be the high-water mark. - Producer prices, both the headline and core,
are also expected to have softened a little. In April 2021, they had increased
by 1.0%.
The composition of inflation
may also be changing.
Used car prices spurred a great deal of discussion last year. Prices are
falling, like Powell suggested would happen when a year ago he drew attention
to used car prices and lumber. The unusual rise in durable goods prices
may be stalling. Shelter costs may pick up the slack.
One of the most important
developments last week was the surge in the swaps market to price in a terminal
Fed funds rate near 3.75%. Some, like the noted economist and former
chief economist for the IMF, Kenneth Rogoff, believes that a considerably
higher rate (5%) may be necessary to break the price spiral. However,
most observers think that the economic conditions will warrant the end of the
tightening cycle before then.
It is not just the domestic
economy either. Headwinds
will emerge globally. Although Europe's April PMI readings continue to show
resilience, the deterioration of consumer and business confidence is
alarming. Germany and French industrial output fell and by more than
expected in March. National governments are cutting growth
forecasts. The ECB has not moved. It continues to expand its balance
sheet. The hawks are pushing for a July hike and the swaps market is
taking the bait. We are less convinced that a consensus for this
crystalized among ECB members. The Bank of England warned that the UK's
output could contract by 1% in Q4 as the cost-of-living bites as energy price
cap is lifted by another 40% in October. The BOE sees the economy
contracting by 0.25% in 2023.
Japan does not report Q1 22
GDP until May 18, but that it contracted will not be a surprise given the
extended Covid restrictions and the earthquake. It is old news in many
respects. Arguably more important is that the recovery is already underway,
and it will be aided by new stimulus measures. The preliminary April
composite PMI rose for a second month, and if confirmed (May 9), it will stand
at a four-month high.
Arguably, Japan's March
current account figures due on May 12 will be noteworthy. First, the first trade surplus in
five months is expected. To be sure though, the trade balance, as we have
noted, does not drive the current account surplus. The capital flows
associated with past investments, such as interest, dividends, profits, royalties,
ad licensing fees, drive Japan's current account surplus.
Second, with the current
account report, Japan also reports portfolio capital flows. The MOF publishes weekly figures,
but the monthly figures include a country breakdown. Recall that the
February report showed Japanese investors sold about JPY3.1 trillion (~$25 bln)
of US sovereign bonds. Some observers have been emphasizing the Japanese
selling of US Treasuries. Often the cost of hedging is cited. The
general flattening of the US yield curve makes hedging the currency risk has
more expensive and eats away at the yield advantage.
However, some Japanese life
insurance companies like Sumitomo recently indicated they were going to
increase the holdings of unhedged bonds. Even more challenging to the
narrative is the fact that the US Treasury International Capital (TIC) report
suggests a more nuanced story. In fact, the TIC report showed Japanese
investors boosted their holdings of US Treasuries by $3.2 bln in
February.
Sometimes the two data sets
tell a similar story. The MOF figures showed Japanese investors sold about JPY143 bln
(~$1.2 bln) in January. The TIC data showed the liquidation of slightly less than $1
bln. And it is not that the TIC data is biased toward less sales by
Japanese investors. In December 2021, for example, the TIC data showed
Japanese holdings of US Treasuries fell by about $24.6 bln. The MOF data
showed divestment was half of that. More work needs to be done to
understand the differences the two time series.
Chinese policies are often
challenging to understand from the outside. It zero-Covid policy is a timely
example. As the virus has mutated it is less deadly even with the China's home-grown
vaccines, which reportedly are less efficient than Moderna and Pfizer's.
The extreme lockdowns are crushing the economy. Consider that the
composite PMI stands at 42.7 and 37.2 for the official measure and the Caixin
version, respectively. Such readings are consistent with an outright
economic contraction.
China reports several data
points for April that will draw attention. First, China's reserves likely fell
dramatically. It could be the largest drop since November 2016 when they
dropped by $69 bln. The TIC data shows that China as reduced its Treasury holding
in recent months by about $26 bln in between December 2021 and February
2022. However, the main culprit will likely be valuation. The
dollar value of its foreign currency holdings (non-US bonds) fell as the
greenback appreciated markedly last month. The euro fell by 4.7% and
sterling was off 4.3%. The Australian dollar depreciated by 5.6% and the
yen slid 6.2%. On top of that, bond prices tumbled in April.
Second, last month's lending
figures will be reported. Aggregate lending soared by CNY4.6 trillion in March. This
lifted the Q1 average of CNY4.0 trillion, up about 17% from the Q1 21 average
and CNY2.6 trillion average for all last year. Seasonal considerations
and the lockdowns warn that lending may have slow to around half of the March
pace.
Third, China's trade balance
is being distorted by the compression of demand due to the Covid
response. Imports
likely fell for the second consecutive month in April on a year-over-year
basis. Exports have been erratic and probably slowed from the 14.7%
year-over-year pace seen in March. China's trade surplus averaged $54.3
bln in Q1, which is up from about $36.2 bln average in the January-March period
last year.
China's monthly trade
surplus averaged $56.4 bln last year. It has practically doubled since 2018 (average
monthly surplus $29.25 bln). When the yuan is appreciating against the
dollar, it makes sense for corporates to convert their hard currency earnings
to yuan quickly. But this is not the case now, and businesses do not need
to be in hurry. Reports suggest the Biden administration is debating
internally whether to remove some of the tariffs on Chinese goods, not as a
boon for Beijing but to ease US inflation.
The US has an average of an
extra 16% tariff on a little more than $500 bln of Chinese goods. Yet, the impact in US measured
inflation would appears small. A recent report from the Peterson
Institute for International Economics calculated that a two-percentage point
cut in the average tariff on the $2.8 trillion of goods the US imports could
shave a little more than one percentage points off GDP. It is unlikely to
be a linear process, but imports from China account for about 18% of US
import. A two-percentage point cut the tariff on Chinese goods might be
worth about 0.2% off measured inflation.
Fourth, China will report
April CPI and PPI. It
was popular in some circles last year to attribute the rise in US CPI to
China's PPI, but it never made much sense to us. And frankly, the data did not
seem to support the thesis. It seems even more fanciful now.
China's year-over-year PPI is expected to have fallen for the sixth consecutive
month. It peaked last October at 13.5% and was at 8.3% in March.
Economists (median forecast in Bloomberg's survey) look for a decline to
7.5%. China's CPI is expected to have edged up to 1.9% from 1.5% in
March. It rose 1.5% in 2021. The deflation in food prices is easing
and non-food prices edged up in February and March. One implication is
that price pressures do not stand in the way of additional measures to support
the economy.
Disclaimer
Reviewed by Marc Chandler
on
May 07, 2022
Rating:
