Daily BriefsMacro

Macro: GDP/ RRR/ Tech/ US-China/ Carbon and more

In today’s briefing:

  • GDP/ RRR/ Tech/ US-China/ Carbon
  • China Growth Outlook: Facing Headwinds, While Exchange Rate Relief Depends on Fed Policy Changes
  • US Wages Are Resurgent, Even if Markets Haven’t Noticed; Keep Your Eye on Inflation
  • Sterling’s Coming Home…albeit Slowly
  • EA: Inflation Nears Its Temporary Trough

GDP/ RRR/ Tech/ US-China/ Carbon

By Diana Choyleva

China News That Matters

  • Slowing, yet still strong
  • A trillion yuan shot-in-the-arm 
  • Breaking into tech’s walled gardens
  • Blacklists, business warnings and a high seas challenge
  • Carbon trading targets power first
  • In my weekly digest China News That Matters, I will give you selected summaries, sourced from a variety of local Chinese-language and international news outlets, and highlight why I think the news is significant. These posts are meant to neither be bullish nor bearish, but help you separate the signal from the noise.

China Growth Outlook: Facing Headwinds, While Exchange Rate Relief Depends on Fed Policy Changes

By Said Desaque

The economic recovery in China is being hamstrung by efforts to quell outbreaks of the Delta variant of the COVID-19 virus, while Chinese vaccine efficacy against the strain is unknown due to the lack of data. Notably, the commercially important province of Guangdong has been impacted by the Delta variant and has prompted calls for supportive policy measures to be undertaken to support the economy.

The People’s Bank of China (PBoC) has recently reduced the required reserve ratio (RRR) for banks, but it is unclear whether lending standards to small and medium-sized businesses will be significantly eased. Reducing the RRR has not been viewed as a harbinger for wider credit easing via lower interest rates, but the PBoC and the Fed could eventually be heading in different policy directions.

Fluctuations in the yuan-dollar exchange rate have been associated with shifts in US financial conditions, notably dollar appreciation has been synonymous with lower degrees of financial accommodation. Private capital outflows from China are repressed via taxation and, consequently, national economic interests play the dominant role in determining the size of Chinese monetary spillovers into US financial markets.

The US currency appears to have bottomed in early-June, but the Fed’s response to rising inflationary expectations could be critical for the dollar, as well as offering potentially China some assistance via a weaker yuan. Historically, the starting point of dollar appreciation versus the yuan, particularly when trading above 6.7, has had a major influence on its impact on US financial conditions, thereby suggesting that trading current levels offer the Fed a limited buffer zone.   

US Wages Are Resurgent, Even if Markets Haven’t Noticed; Keep Your Eye on Inflation

By Prasenjit K. Basu

The US consumer price index (both headline and core) rose at an annualized pace of 10.8% MoM in June 2021. For 2Q (April-June) 2021, the core CPI increased at an annualized pace of 10%, while the headline CPI increased 9.2% (annualized) in 2Q 2021. We had predicted precisely this outcome on 12 June 2020 (13 months ago) in Labour Market Slack Remains but FOMC Will Need to Tighten by Mid-2021 because inflation would rise markedly. While the FOMC has insisted that inflation is transitory, it actually began a stealth tightening in May 2021, engineering a month-on-month decline in the monetary base that month. 

CPI inflation is currently being under-estimated, because the Housing component is properly updated only half-yearly after a complete national survey of rentals and owners’ equivalent rents (OER, the implicit rent that would be paid by homeowners were they to rent rather than own their home). The Case-Shiller 20-city housing price index was up 14.9% YoY in April 2021 (the latest data, released at end-June 2021), and this is bound to enter the CPI and PCE price index in 2H 2021. (Housing is considered an investment, not consumption, so rents and OER are the consumption portion; housing prices are not directly relevant to CPI, the cost of using housing — rents — are). Having risen just 2.6% YoY in June 2021, Housing is likely to rise much more sharply in 2H 2021, pushing up headline and core CPI (and also PCE, but less because of its lower weight). 

The labour market retains some sectoral slack in the hospitality and tourism-related sectors, but appropriately skilled labour is increasingly in short supply elsewhere in the economy.  Despite a high base from June 2020 (5% YoY), average weekly earnings (wages) were up 3.6% YoY in June 2021. Wage inflation will likely exceed 4% YoY in 3Q 2021, contributing additionally to inflationary pressure. St. Louis Fed President James Bullard (a non-voting member of the FOMC this year) has already called for tapering to begin (as “substantial progress” has already been made on the Fed’s inflation and unemployment goals). While Fed Chair Powell insisted in his House testimony this week that tapering remains “a ways off”, he told the Senate on the following day, “…of course we’re not comfortable with” the fact that the reopening of the economy had “driven inflation well above 2%”. The 27-28 July FOMC meeting will likely see more intense discussion of tapering, and we think formal (not merely stealth) tapering will be begin no later than the September meeting. We remain cautious about equities, although the strong recovery makes cyclicals and consumer cyclicals attractive. 

Sterling’s Coming Home…albeit Slowly

By Olivier Desbarres

Despite buoyant domestic expectations (or at least hope) football will not be coming home after the England football team lost on penalties to Italy in Sunday’s final of the Euro Championship but Sterling is arguably coming home, albeit slowly.

The GBP/EUR cross has this week traded mostly above 1.17, a level which has proven hard to break. GBP/EUR is up about 0.6% since late-June, in line with our modestly bullish view, and we expect further modest appreciation in the remainder of Q3 (see “Sterling leads Euro 1-0 at half-time in dull encounter but could extend advantage”, 29th June 2021).

The catalyst for Sterling’s outperformance versus the Euro has arguably been the widening differential between UK and Eurozone CPI-inflation, the Bank of England’s more hawkish rhetoric relative to a still very dovish European Central Bank and markets upping their pricing of Bank of England policy rate hikes.

The recent hawkish pivots by Monetary Policy Council members Ramsden and in particular Saunders may not yet enjoy consensus support. However, it is increasingly clear, in our view, that the MPC is divided (and vocally so) as to if and when it should prematurely terminate its QE program and when it should start hiking its policy rate.

The rates market, which is now pricing in 21bp of Bank of England hikes by mid-September 2022, is seemingly siding with the hawks which is in turn providing some ammunition (even if still a little blunt) to Sterling bulls.

We expect reasonably robust UK GDP growth in coming months to push headline CPI-inflation above the Bank of England’s “peak forecast” of 3% yoy. We are thus sticking to our view that the gap between UK and Eurozone growth and CPI-inflation will widen further and see the Bank of England becoming increasingly hawkish, in absolute terms and relative to the ECB.

Finally, the typically very large UK tourism deficits, including with Eurozone countries, are likely to be far smaller than normal in July-August, which could in turn up-end Sterling’s typical seasonal weakness versus the Euro in these two months.

EA: Inflation Nears Its Temporary Trough

By Phil Rush

  • EA HICP inflation for Jun-21 was confirmed at 1.9% y-o-y while the ex-tobacco index also matched our forecast. Upside news in clothing was balanced by downside in package holidays where we moderate the potential positive payback in July.
  • We continue to forecast another fall to a temporary trough in July, driven by weighting changes and base effects. The high 1.6% outcome would be below the current consensus, but our 2.9% peak and 1.6% average in 2022 are relatively elevated.

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