Economist Ren Zeping: What is the impact of the Fed's release of interest rate cut expectations on China?
Text: Ren Zeping's team
At the March Fed interest rate meeting, it announced that it would keep the federal funds rate unchanged at 5.25%-5.5%, in line with market expectations.
1 FOMC: Keeping interest rates unchanged, cutting interest rates three times this year, and raising economic expectations
The Fed kept its guidance unchanged for three rate cuts in 2024, corresponding to a median federal funds rate of 4.6%. The dot plot in March shows that interest rates will be cut three times in 2024, each time by 25bp, and basically a consensus with the market. FedWatch predicts that the probability of the first rate cut in June rises to 75.8%, and the rate cut for the whole year is 75bp. Due to the optimism about the economic forecast, the rate cut in the next two years has been lowered, with the forecast for 2025 being 3.9% compared to 3.6% previously, and the forecast for 2026 being 3.1% versus 2.9% previously. In addition, the neutral interest rate is expected to be raised from 2.5% to 2.6%, and the technological revolution and anti-globalization will push up the high interest rate, squeezing the room for future interest rate cuts.
The interest rate cut is based on a "better balance" between inflation and employment, ensuring that the unemployment rate does not rise sharply, and aiming for a sustained decline in inflation. The Fed believes that the current job market is strong, and in terms of expression, it changed "employment continued to slow" in January to "employment remains strong". "The current rebound in inflation has not reduced confidence in achieving the 2% target, and remains highly concerned about inflation risks" and that "the labor market, inflationary pressures, inflation expectations, financial and international developments are the main considerations for the Fed".
The Federal Reserve is optimistic about economic expectations, raising GDP and inflation forecasts, and lowering unemployment forecasts. In the Summary of Economic Projections (SEP) for March, GDP is forecast at 2.1% vs. 1.4% previously, core PCE is forecast at 2.6% vs. 2.4% prior, and unemployment rate is forecast at 4.0% vs. 4.1% previously. In addition, the GDP forecast for 2025 and 2026 has been revised upwards from 1.8% and 1.9% to 2%, respectively. It means that the Fed's economic expectations are close to a soft landing or no landing.
The Federal Reserve has expressed a dovish stance and raised inflation and economic forecasts, but kept the rate cut unchanged this year, reflecting increased confidence in the economy and political demands for interest rate cuts in the U.S. election year. Short-term capital market trading is loose, U.S. stocks rose for three consecutive trading days, the three major stock indexes hit record highs, gold strengthened and then fell slightly, COMEX gold rose to 2192.2 on March 20, after a restorative pullback, U.S. Treasury yields lower, March 20 10-year Treasury yield at 4.27%, the previous value of 4.30%. In addition, the Fed raised its long-term interest rate forecast, which means that the era of "high inflation, high interest rates" may arrive, and assets will be repriced.
2 What is the economic situation in the United States?
At present, the U.S. economy is relatively resilient and still growing at a pace higher than potential. Employment data exceeded expectations, unemployment rate stabilized, housing prices bottomed out, real estate chain picked up, but inflation slowed down, specifically,
First, with the rising expectations of interest rate cuts and the lack of real estate supply, the major U.S. home price indices have bottomed out. In December last year, the housing price index of 10 cities was 7.0% year-on-year, and the housing price index of 20 cities was 6.1% year-on-year. While new residential construction permits continued to grow steadily, new construction starts increased significantly. In February, there were 1.518 million new residential construction permits, up 1.9% month-on-month and 2.4% year-on-year, and new construction starts were 1.521 million units, up 10.7% month-on-month and 5.9% year-on-year. After bottoming out in U.S. real estate at the end of 2022, low inventory and improved real incomes will support existing home sales in 2023. In January, the inventory of existing homes was 1.01 million units, and the existing home sales were 4 million units, while the vacancy rate of owner-occupied homes was 0.9% and the home ownership rate was 65.7% in December.
Second, consumption remains relatively resilient. Total retail sales in February were 0.6% m/m vs. -1.1% previously, while core retail sales were 0.3% vs. -0.8% prior. Automobiles, retail without stores, and food and beverages were the main contributors, accounting for 17.3%, 16.8%, and 11.8% of total retail sales, respectively. Specifically, automobile sales increased by 1.4% year-on-year and 1.8% month-on-month, retail sales without stores increased by 1.2% year-on-year and -0.1% month-on-month, and food and beverage sales increased by 1.9% year-on-year and 0.1% month-on-month.
In February, the weather in the United States improved, and service consumption heated up from the previous month. Retail sales of food and beverage bars, sports and entertainment, and grocery stores expanded by 0.5%, 0.02%, and 0.6%, respectively. In addition, the recovery of real estate has driven the consumption of the real estate chain. Retail sales of building materials, electronics and household appliances were 2.2% and 1.5% month-on-month.
Third, the process of disinflation has slowed down. In February, the US CPI was 3.2% year-on-year, and the previous value was 3.1%; The CPI was 0.4% month-on-month, compared with 0.3% in the previous month, and the core CPI was 0.4% month-on-month, exceeding expectations for two consecutive months. Core PCE fell back to 2.8% YoY, in line with expectations, but still above the 2% inflation target. Food & Beverage, Housing, Energy, Transportation, and Healthcare are the main contributors.
Housing has a high weight in the CPI (45%), and deinflation is very limited, with residential housing at 4.5% YoY and 4.5% MoM in February, while housing rents were 5.8% YoY and 0.4% MoM. The year-on-year price of the United States has bottomed out in June 2023, and the lagged impact of home prices will bring a new round of upward pressure on housing inflation as soon as the second half of 2024.
Fourth, the job market is strong. 275,000 new non-farm payrolls were added in February, with an average monthly increase of 251,000 in 2023, 204,000 new jobs in service production, and 19,000 new jobs in goods production. In the production of services, 85,000 people were newly employed in education and health services, 58,000 in leisure and hotel services, and 20,000 in warehousing and transportation. In the production of goods, 23,000 new jobs were created in the construction industry. In terms of stock breakdown, the production of goods represented by the manufacturing industry fell month-on-month, with automobiles -0.04% month-on-month, non-durable goods -0.12% month-on-month, warehousing and transportation represented by service production by 0.3% month-on-month, public utilities by 0.55%, and education and health services by 0.33% month-on-month.
The unemployment rate remains low and the labor market is tight. The U.S. U1-U6 unemployment rate edged up, and the employment data was resilient. The unemployment rate was 3.9 percent, up 0.2 percentage points from the previous month, and the U6 unemployment rate was 7.3 percent, up 0.1 percentage points from the previous month. The labor force participation rate was 62.5%, unchanged from the previous month. Hourly earnings slowed month-on-month, mainly due to the lack of labor during extreme weather last month, while average hours increased by 0.3% month-on-month, while average hourly earnings fell to 0.1%, but average wages rose by 4.3% year-on-year, and the slowdown was still limited.
3 The U.S. replenishment cycle is good for China's two major export chains
The U.S. manufacturing PMI rebounded for two consecutive months, with China's exports rising to 7.1% year-on-year in January-February, and exports to the U.S. rebounding to 5.0% year-on-year. Follow-up focus on China's two major export chains: one is to pay attention to the industry-related exports of the United States that took the lead in entering the replenishment cycle, and the other is the post-cycle real estate industry-related exports.
This round is a weak replenishment cycle, and manufacturers and wholesalers have weaker replenishment motivation than retailers. In January, manufacturers' inventories and wholesalers were -0.5% and -2.5% year-on-year respectively, at the historical high quantile of 54.8% and 69.9%, and retailers were 5.0% year-on-year, at the 47.6% quantile level. In terms of the inventory-to-sales ratio, the inventory-to-sales ratio of manufacturers in January was 1.5 days, higher than that of wholesalers and retailers of 1.36 days and 1.33 days.
The current U.S. inventory cycle presents three major characteristics: 1) The degree of destocking of non-durable goods is stronger than that of durable goods. 2) Among the non-durable goods, "clothing, agricultural products, chemicals, paper products, and miscellaneous products" are completely destocked, while the inventory level of "medicines and alcohol" is relatively high. 3) Among durable goods, "furniture, hardware, and miscellaneous products" are completely destocked, while "machinery and equipment, automobiles and parts" have a high inventory level.
China's labor-intensive exports rebounded sharply in February, corroborating the U.S. replenishment cycle. The export value of non-durable goods consumer products represented by textiles, clothing, toys and bags was 15.5%, 13.1%, 15.9% and 24.1% year-on-year respectively, while the export value of durable goods and real estate chain represented by furniture and lamps was 36.6% and 30.5% year-on-year.
It is worth noting that the current U.S. destocking of relatively thorough non-durable goods has limited potential pull on China's exports. If we measure the export of non-durable goods to the United States in a broad sense (HS categories 4/6/7/8/9/10/11/12), their exports account for only 25% of the mainland's exports to the United States and 3.7% of the total export value.
Considering that the year-on-year growth rate of 5% is calculated, the potential export pull to the mainland is less than 0.2%, and it is not the decisive force for the export recovery in 2024. Overall, China's labor-intensive exports to the United States can expect to continue to recover in 2024, but they will not significantly improve the total volume.
The $4 rate cut is positive for global capital flows
Good for gold, copper and other non-ferrous metals. The expectation of a Fed interest rate cut has further catalyzed the prices of gold and non-ferrous metals, and the fundamental logic of the continuous rise in gold prices is a shift in the global macro paradigm. As of March 21, CRB metal and gold prices averaged $1,014.3 and $2,157.1 per ounce month-on-month, respectively, up 7.2% and 29.5% from their lows in October 2022.
If the Fed cuts interest rates, the inversion of the interest rate differential between China and the United States and capital outflows will be alleviated, and the depreciation of the RMB exchange rate will also be eased.
Under the Fed's interest rate hike cycle, the US dollar is strong, and economies often face problems such as capital outflows, currency depreciation, external debt pressure, and economic recession. For example, under the Fed's interest rate hike cycle, the currencies of Turkey and Argentina have depreciated severely. Compared to 2022, the average depreciation of the currencies of Turkey and Argentina in 2023 is 43.4% and 125.7%.
For China, the US Treasury bond yield has risen rapidly under the Fed's interest rate hike, China's monetary policy is loose, the interest rate differential between China and the United States has inverted, and the 10-year Treasury bond yield spread between China and the United States has been negative in May 2022, the overseas holding of RMB assets has slowed down, the RMB exchange rate has begun to depreciate, and capital has flowed out.
Recently, the U.S. dollar index has rebounded slightly, although the Federal Reserve maintained the expectation of three interest rate cuts this year, but the Swiss National Bank took the lead in cutting interest rates by 25bp, and the Bank of England and the European Central Bank were obviously dovish, briefly pushing up the U.S. dollar index.
However, in the medium term, with the gradual recovery of China's economy and the fulfillment of the Fed's interest rate cut expectations, the pressure on RMB depreciation has slowed down and the capital market has shown positive signals. Since February 5, the RMB exchange rate against the US dollar has remained around 7.19, and the Shanghai Composite Index has risen and fallen by 9.02% from February 8 to February 18, and has begun to recover.