October inflation in the US and China featured in the coming week
The cycle of major central bank meetings is over. Anglo-American central banks and Norway lead high-income countries in adjusting monetary policy. Meanwhile, the pandemic continues to cause scars and flare-ups are spreading economic and social disruption in some major countries, including China and Russia. Parts of Europe are experiencing another wave, including Ireland, the UK and Germany.
From the RBA and the ECB to the Bank of England and the Federal Reserve, central banks have pushed back the dramatic drop in short-term rates with varying degrees of fury. Two-year yields, a useful indicator, fell 10 in the US and 12 in Germany and almost 28 bps in the UK. The implied yield on Fed funds futures for December 2022 fell 11 bps. The implied return on the June 2022 contract fell less but hit its lowest level in two and a half weeks.
Attention is now turning from central bank meetings to economic reports that will influence future monetary policy. Four economic data stand out. The United States releases the October CPI and the University of Michigan’s preliminary long-term inflation forecast for November, China’s inflation measures and the October Australian employment report. In addition, the UK reports third quarter GDP and September details.
Before taking a closer look at these highlights, let’s talk briefly about the two central banks that meet each other: Peru and Mexico. The first is interesting, not because global investors and companies are very exposed. On the contrary, the unorthodox government respected the independence of the central bank, re-appointed the respected central bank chief for another five-year term, and made reasonable appointments to the central bank’s board. The central bank rose by a quarter point in August (to 0.5%) and moved 50bp in September and October. Like other countries, Peru struggles with rising prices as the economy reopens. Last month, the CPI (Lima) accelerated to 5.83% from 5.23%. Unemployment (Lima) in September fell from 9.5% to 10.0%. This is the second consecutive monthly increase and illustrates the dilemma faced by policymakers in several emerging market economies.
Mexico’s central bank is grappling with a similar problem. The economy unexpectedly contracted in the third quarter and inflation accelerated. The October CPI will be released a few days before the Banxico meeting on November 11. President AMLO has been more active in overhauling the central bank’s board than Castillo in Peru. However, only one has resisted the logic of rate hikes. At 4.75%, the overnight rate is still lower than the inflation rate (6.0% in September and the bi-weekly estimate put it at 6.12% in the middle of last month. The central bank increased by 25bp in June, August, and September The swap market is valuing around 110bp over the next three months, implying the risk of a 50bp move now.
US inflation and inflation expectations are high, but they are not accelerating. The headline CPI rose at an annualized pace of about 4.8% in the third quarter after rising nearly 10% in the second quarter. At an annualized rate, the key rate rose by about 2.5% in the third quarter after rising more than 10% in the second quarter. Two frequently cited measures of market-based inflation expectations, the 10-year break-even point and the five-year five-year expectation, have fallen 20 to 30 bps since their peak in late October. The University of Michigan’s long-term (5-10 year) inflation expectations survey reached 3.0% for the first time in May. It has rebounded between 2.8% and 3.0% since then. In October, it stood at 2.9%.
Due to the fact that the headline CPI rose only 0.1% in October 2020, the 0.5% increase economists forecast for last month will see the year-on-year rate rise to 5.8% (against 5.4%). Plus, it looks like the latest, base prices grabbed the headlines. Excluding food and energy, consumer prices should have increased by 0.4%. With the base effect of October 2020’s 0.1% gain coming out of the 12-month calculation, the base rate could rise to 4.3% from a year ago.
The price pressures have been stronger and are lasting longer than expected. Still, that doesn’t really negate the underlying view that acceleration reflects the base effects, supply chain disruptions associated with closing and reopening. It also makes sense that the Anglo-American economies, which tended to provide more fiscal stimulus and generally experience higher inflation than, say, the Eurozone, Switzerland and Japan, would do so again. What matters in this context is the cyclically adjusted fiscal push. The United States is past the stimulus peak.
The reduction in emergency transfer payments means several hundred billion dollars less fuel for consumption. Consider that US consumption before the pandemic was fairly stable, with annualized average growth of 2.3% in 2019, 2.4% in 2019-18 and 2.5% over the last 20 quarters (five years) . The third quarter GDP report gave us an idea of what to expect as consumption grew at an annualized rate of 1.6%, but even with that the average for the first three quarters is still intoxicating. by 8.3%. It seems to be rebounding this quarter and could on average be slightly better than 3% in H1-22 before returning to its pre-pandemic averages in H2.
As a result, companies will build new capacity and repair supply chains, but (consumer) demand is likely to slow. Treasury Secretary Yellen suggests that price pressures may persist into the middle of next year. President Powell appeared to echo the remarks during his press conference after last week’s FOMC meeting. It seems like a reasonable scenario. This may help explain why the market is waiting for the policy tightening to stop ahead of the Fed’s long-term rate of 2% to 3%.
Unlike inflationary worries in Europe, North America and many emerging markets, consumer price pressures in China are modest no matter how the data is sliced. In September, the CPI was 0.7% above the levels of the previous year. In September 2020, it increased 1.7% year-on-year. In the third quarter, it increased by just over 1.6% on an annualized basis after falling more than 3.5% on an annualized basis in the second quarter. Food prices are part of the story. Food prices, driven by the rebuilding of the pig herd and lower pork prices, fell 5.2% year-on-year in September, but non-food prices rose a modest 2%. Excluding food and energy, core inflation stood at 1.2%. The prices of goods rose 0.2% year-on-year, while the prices of services rose 1.4%.
China’s call for households to secure their winter supplies could push up the prices of some consumer goods and food. In connection with the debt crisis in the Chinese real estate sector, house prices seem to be slowing down. Measured by retail sales, consumption slowed (year-on-year) from February to August before picking up again in September. However, the most compelling reason to expect the Chinese CPI to accelerate is the base effect. Last October (and November), the Chinese CPI fell 0.3% (and 0.6%). Indeed, the increase could be dramatic.
Producer prices are another story. In the year to September, Chinese producer prices rose 10.7%. Efforts to liquidate part of the State’s strategic reserves (acquired during previous attempts to support prices) do not seem to have a noticeable impact on prices. That said, many essential industrial products, such as petroleum, copper, iron ore, and coal, are lagging behind, meaning short-term prices are higher than delayed deliveries. In the United States, the pace of producer prices year-over-year probably stabilized in October around 8.6% and 6.8% for the headline and base interest rates, respectively. . The base effect warns that further acceleration is likely this month.
The Reserve Bank of Australia opposed the anticipated tightening of the market and continued to focus on the labor market. It should be remembered that social restrictions resulted in the loss of nearly 285,000 jobs in August and September. The composite PMI index had remained stuck below the expansion / recession level of 50 and fell to 52.1 in October from 46.5 in September. However, the investigation period runs from September 26 to October 9, which suggests that the impact of the Sydney and Melbourne closures could hamper the October jobs report. Nevertheless, there is reason to be optimistic about the recovery of the labor market in the coming months.
The Bank of England meeting took thunder from the preliminary estimate of Q3 GDP on November 11. The new information is actually for September, and the central bank has warned that growth prospects have deteriorated since August due to supply disruptions. Monthly GDP figures showed a contraction of 0.1% in July and a weaker-than-expected recovery in August (0.4%). Until August, monthly GDP grew by about 7.5% at an annualized rate.
Monthly GDP is ahead of the quarterly calculation, which the BOE predicts. There is a methodological difference between the two time series. The monthly uses gross value-added output, while the quarterly GDP estimate averages measures of output, income and expenditure. It would have taken a strong surge in activity in September to validate the quarterly growth forecast of 1.5% (Bloomberg median). Given the unexpected drop in retail sales in September, we believe the risk is on the downside.
Employment data for November 16 (claimant counter for October and earnings, employment and unemployment figures for September) may be the key to whether interest rate expectations are mounting for a move of December. After the BOE meeting, the shrinking market assessed a little more than a 50% chance of a rise before the end of the year. A move is fully discounted for the first meeting in 2022 (February 3).