Week Ahead: RBA and BOC Meetings Featured and China's Inflation and Trade

The week ahead is more than an interlude before five G10 central banks meet on December 14-15. The data highlights include the US ISM services and producer prices, Chinese trade and inflation measures, Japanese wages, household consumption, and the current account. Also, the Reserve Bank of Australia and the Bank of Canada hold policy meetings. Central banks from India, Poland, Brazil, Peru, and Chile also meet.

The dollar appreciated in Q1 and Q2 despite the economy contracting and dramatic widening of the trade deficit (averaged $65.9 bln in Q4 21, $71.9 bln in Q1 22, and $75.4 bln in Q2). The precise performance of the US economy in Q4 does not matter much to the financial markets. The Atlanta Fed GDPNow tracker is a little lower than 3%, while the median forecast in Bloomberg's mid-November survey was shaved to 0.5% from 0.7% the month before.

Given the focus on inflation, the US November PPI will attract attention. The monthly PPI change has been a net zero in the four months through October. A modest increase of 0.3% in November would, given the 1% increase in November 2021, allow the year-over-year rate to fall to around 7.3% from 8.0%. Producer prices peaked at 11.7% in March, just as the Fed began to lift rates. The core measure is drifting up by around 0.2% and could see the year-over-year rate to 6.0% from 6.7%. It also peaked in March (at 9.7%). But, of course, for market participants and the Federal Reserve, consumer inflation is more important. The November CPI will be released as next week's FOMC meeting begins. It looks set to continue to moderate. The headline rate may slow toward 7.3% (from 7.7%), and the core rate could slip to around 6.1% (from 6.3%).

If neither trade nor growth could have predicted the dollar's performance, the same is generally true of China. The yuan was about 0.25% firmer in Q1 when the economy expanded by 1.6% (quarter-over-quarter), and the average monthly trade surplus slumped to $51.5 bln from $83.0 bln in Q4 21. The economy contracted by 2.7% in Q2, and the average trade balance surged to $74.4 bln. The yuan depreciated by nearly 5.4%. Chinese growth rebounded by 3.9% in Q3, its fastest pace since Q2 20. The July month trade surplus poked above $100 bln, and in any event, averaged $88.3 bln, a new quarterly record. The yuan's decline accelerated; it lost almost 5.9% against the dollar.

What is often overlooked in discussions about China's trade balance is the role of foreign companies. Foreign businesses are often forced into partnerships with domestic companies. Hence, we need to talk about foreign-invested enterprises. They account for a full third of China's exports and more than 40% of its imports. An important shift that has taken place is that China's exports have a lower share of foreign inputs. In some ways, the process is similar to what happened in the US. For example, Japanese car parts manufacturing joined the automakers to benefit from the stronger yen and get around US protectionist measures (see voluntary export restrictions).

China's inflation measures will also attract attention. Remember when many economists tried drawing a link between Chinese producer prices and American consumer prices. Forget about it. Weakness in the property market and Covid-related restrictions likely dampened activity and prices. China's PPI has been slowing uninterrupted beginning last November, and in October was negative for the first time since the end of 2020. Key commodity prices were mixed in November. Brent fell by around 10.5%, iron ore surged by 30%, and copper rose by 9%. Soybeans edged about 2% higher. Producer prices are expected to fall 1.4% from year-ago levels, slightly more than in October (-1.3%).

Consumer prices moderated 2.1% from a year ago in October, matching the low end of the range that has prevailed since April. They liked slowed further last month to around 1.6%. Food prices are key. They rose 7.0% year-over-year in October and have risen sharply since Q1. Non-food prices rose 1.1% and have not been above 2% since mid-year. The core rate was at 0.6% in September and October. Consumer goods prices rose 3.3% in October, the least since May. Service prices rose by a minor 0.4% in October, the least since March 2021. Inflation does not stand in the way of additional easing by the central bank.

Two G10 central banks meet in the week ahead, the Reserve Bank of Australia (December 6) and the Bank of Canada (December 7). The RBA is the trickier of the two. It waited until May to begin tightening and downshifting after four half-point moves to 25 bp in October and November. Governor Lowe seems more sensitive to the economic slowdown that is already hitting housing and consumption. While the swaps and futures market expected hikes next year, they are not convinced that it will move now. The market has slightly more than a 50% chance of a quarter-point move discounted. Meanwhile, the Australian dollar is at two-and-a-half month highs, having rallied 11% off mid-October lows. 

Australia also reports Q3 GDP next week. It expanded by 0.7% in Q1 and 0.9% in Q2. The median forecast in Bloomberg's survey projects 0.7% growth in Q3. Australia also reports its October trade balance. It has recorded an average monthly surplus of A$11.3 bln a month this year, which is practically twice the average of the Jan-Sept 2019 period. Recall that as the trade surplus swelled to an average of A$14.6 bln in a month in Q2 23, the currency fell 7.7% against the US dollar, the largest quarterly loss since 2013.

The market is more confident that the Bank of Canada will lift its target rate by a quarter-of-a-point to 4.0%. The central bank surprised the market with a 100 bp hike in July. It delivered a 75 bp hike at its next meeting in September and 50 bp in October. It did not meet in November. The effect of the past tightening is evident in the housing market and consumption. The swaps market sees the terminal rate around 4.25%, with around a 25% chance it peaks at 4.50%. Over the past 60 sessions, the exchange rate has become more correlated with the two-year rate differentials (with the US), though around 0.32, it is still less than half the correlation with the S&P 500 (proxy for risk). The 60-day correlation of changes in the exchange rate and WTI has been fairly stable since June and is now around 0.52.

Five emerging market central banks meet in the week ahead. However, the most interesting from a capital markets point of view, Brazil, Poland, and Chile, are expected to stand pat. Officials hope that the tightening cycle is complete. India and Peru have more work to do, and both will likely lift rates. India has raised the repo rate by 50 bp at the last three meetings after kicking off the normalization process with a 40 bp hike in May. The RBI may slow the pace, but the swaps market sees another 75 bp over the next six months, with a terminal rate near 6.65%. Peru's central bank has hiked its policy rate every month beginning August 2021. As a result, the reference rate has risen from 0.25% to 7.25%. The market looks for another 25 bp hike on December 7, which could be the last.

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