The Global Week Ahead: China Covid Gamble Keeps Inflation Risk Alive

Next Week's Risk Dashboard

• China’s tumbling mobility…
• …and the risk of further supply shocks
• BoJ: No pivot yet…
• …but the BoJ could disrupt world markets in 2023
• Chinese banks might cut lending rates
• Bank Indonesia likely to hike again
• Turkey’s central bank is probably done messing up
• Canadian inflation: soft headline, solid core?
• Canadian economy: modest Q4 growth?
• US macro dump

An abridged version of this article owes itself to a combination of what is a relatively light coming week for global calendar-based developments, mercy toward readers after this past week’s central bank—driven market turmoil, and having been a tad under the weather myself.

In fact, this week could bring a return to random off-calendar developments dominating calendar-based risk and especially slanted toward China’s high stakes gamble to drop covid restrictions and further developments in the war in Ukraine.

That a covid surge in China is causing folks to withdraw from the economy is evidenced by alt-data such as tumbling use of subways in major cities (chart 1). Travel and trade linkages could once again make Covid China’s fastest growing export into the new year. While the consequences would be a much more muted version of the start of the pandemic, the pattern of serial supply-side shocks could be further aggravated by disruptive and inflationary effects upon global supply chains and labour markets. I think this is among the reasons why we heard central banks guide this past week that they continue to judge inflation risk as skewed higher rather than lower.

CENTRAL BANKS—COULD THE BoJ BE THE NEXT SHOE TO DROP?

It’s next to impossible to top the impact that major central banks had upon global markets over this past week. Only four central banks will be on market radar over the coming week and none of them are expected to impact global markets but at least one of the could be at risk of a powerful pivot next year.

Bank of Japan—Stay Tuned!

The Bank of Japan delivers its latest policy decisions on Tuesday. While no changes are expected at this meeting, it’s feasible that policy change may be afoot as 2023 unfolds.

The policy statement is expected to be very similar if not entirely identical to the one issued the last time on October 27^th (here). The policy balance rate of -0.1% is expected to be unchanged. The statement is also likely to retain unchanged language on Yield Curve Control that says they will continue to buy 10-year JGBs in sufficient quantities so as to maintain a yield of “around zero percent” and implemented on a ceiling basis at 0.25%.

Key, however, is the potential intersection of faster wage growth and a new Governor next year. Governor Kuroda’s decade-long term will be up in April and a successor is expected to be announced probably early next year. That coincides with annual Spring labour-management wage negotiations that may finally deliver the missing ingredient to durable achieving the BoJ’s 2% inflation target.

At the moment, inflation is running at nearly double that pace (3.7% y/y) with a November update due on Wednesday evening (eastern time as always in this article). Kuroda has downplayed the sources of this inflation as incompatible with durably achieving the central bank’s inflation target given its transitory drivers including yen depreciation plus food and energy price inflation in the absence of stronger wage growth. Real wages continue to be crushed (chart 2).

Unlike concerns about the potential for a wage-price spiral that could unfold elsewhere such as the US, Eurozone and Canada, the BoJ would welcome such a development to a degree. This was clearly expressed in the Summary of Opinions published after the October meeting (here) that stated the following:

“While there is concern over a wage-price spiral in Europe and the United States, a virtuous cycle between wages and prices has not been achieved in Japan. Including this factor, the Bank needs to carefully explain the reasons behind the differing direction of monetary policy between Japan and overseas economies.”

“If firms' current price-setting behavior and moves to increase wages take hold and a virtuous cycle between prices and wages operates, sustainable and stable achievement of the price stability target of 2 percent will come in sight.”

The BoJ has also made clear that it will be following annual Spring wage negotiations for evidence that this is unfolding:

“From the second half of fiscal 2023, underlying inflation is projected to gain momentum on the back of improvement in the output gap and rises in inflation expectations and in wage growth. The key to this outlook is wage developments reflecting the annual spring labor-management wage negotiations.”

“For wages to increase, it is crucial that firms' growth expectations rise.”

Such evidence may be unfolding. The Japanese Trade Union Confederation (“Rengo”) recently finalized a plan to seek a pay hike of about 5% in the upcoming shuntō spring labour management negotiations, up a percentage point from prior years. What could weigh against this target is the dampened confidence of the business community’s growth expectations in the face of a deteriorating global outlook.

For now, however, the central bank says that “In order to achieve the price stability target while increasing the likelihood of wage inflation being realized, it is appropriate for the Bank to continue with the current monetary easing” and how “it is undesirable to make premature changes to monetary policy because they have a risk of disrupting the formation of a virtuous cycle between prices and wages.”

The chance to reassess this dynamic isn’t likely to occur before Kuroda’s term is up in April. At that point it’s feasible that talk of a policy review gains traction and may lead to a pivot with uncertain consequences. A BoJ policy pivot could offer powerful effects across world markets through the implications for carry out of very low yielding JGBs into sovereign benchmarks elsewhere and depending upon how market assessments of the cost of hedging yen versus dollars and euros may evolve.

Chinese Banks & the PBoC

After the People’s Bank of China left its 1-year medium-term lending facility rate unchanged at 2.75% this past week, the odds of a cut to the one-year Loan Prime Rate on Monday moved to near zero. Cuts in LPRs often, but not always, require the central bank to lead with reductions in the facility rate (chart 3).

It’s possible that commercial banks may deliver a token cut to the five-year Loan Prime Rate which is more consequential to the property market. This could reflect policy efforts to ease financing in targeted fashion including toward the beleaguered property sector. Those efforts have included reductions in required reserve ratios and an acceleration of lending volumes through the medium-term facility in excess of maturities.

Nevertheless, shorter-term funding pressures have continued to become more acute and further policy action may be needed in support of property markets (chart 4). 

Bank Indonesia Likely to Hike Again

Bank Indonesia is widely expected to deliver another rate hike of at least 25bps on Thursday. Inflation is running at 5.4% y/y with core at 3.3%, both of which are above the mid-point of the central bank’s 2–4% inflation target rate. While it has stabilized in the most recent estimates, the rupiah has depreciated by about 5% to the USD since September and may pose further lagging effects to inflation and stability.

Turkey’s Inept Central Bank

After President Erdogan succeeded in his quest to drive Turkey’s central bank to cut the one-week report rate into single digits, most within consensus don’t expect further reductions to the 9% rate on Thursday. Easing should have never occurred in the first place with inflation running at 84% y/y and the lira having collapsed in value to the USD from about 8 in September 2021 to almost 19 now. The country’s central bank is the poster child for what could go wrong when critics of tightened monetary policy elsewhere who would prefer easier monetary policy at home would be courting by way of the devastating consequences.

CANADIAN INFLATION AND GDP GROWTH COULD INFORM BoC PRICING

Updated inflation and growth estimates might be at least temporarily impactful to market pricing for the Bank of Canada’s next policy rate decision on January 25^th given the central bank’s conditioning around extreme data dependence. Much more information will arrive in the new year with another inflation report on January 17^th, another set of the BoC’s quarterly surveys for Q4 on January 16^th that include measures of expectations for inflation and wage growth and another report on jobs and wages on January 5^th.

At the margin, however, this heightened data dependence is out of sync with more hawkish central banks elsewhere such as the Fed and ECB. Those central banks have adopted a stronger tendency to offset previously easing financial conditions they probably felt were getting ahead of policymakers’ comfort zone. Differences of opinions across these central banks around the direction and magnitude of inflation risk and implications for markets could settle in such a way as to risk further weakening of the Canadian dollar into the first few meetings of the new year and this may yet force the BoC’s hand after having left the door partially open to further rate adjustments at its recent meeting and subsequent communications.

Canada updates CPI for the month of November on Wednesday. It’s one of two inflation readings that the Bank of Canada will receive before its next decision on January 25^th, 2023. With this one it may be more important than recently usual to look past the headline number to the details.

I’ve estimated a drop of -0.2% m/m for total CPI measure in seasonally unadjusted terms as per the survey convention. That would translate into a roughly flat change for total CPI in seasonally adjusted terms. That’s because November is typically a down month for seasonal price influences. For example, it seems that if you haven’t bought a new winter coat when it’s still hot out then by November there is usually less choice and sales tend to kick in. Gasoline prices will also weigh on the headline as they fell by about 2½% m/m. Food prices may have offset some of that by adding a weighted 0.1% to m/m CPI.

Traditional core inflation, however, might be a different story and will further inform the recently softening trend (chart 5). Seasonally adjusted CPI ex-food and energy is estimated at +0.3% m/m. That would remain down from the super elevated readings earlier in the year but would still be running at about a 4% annualized rate and hence double the BoC’s 2% headline CPI target. 

If market participants fail to look beneath the headline inflation reading to the underlying details in terms of core inflation and breadth, then a weak reading could chip away at pricing toward half of a quarter point rate hike on January 25^th. That might be the instant reaction, especially if there is a further downside surprise, but there may be room for a second trade upon looking at the details.

Canada will also update growth figures. Friday’s GDP release for October was initially guided toward being “essentially unchanged” by Statcan back on November 29^th. That usually suggests something between about -0.1% m/m and +0.1% m/m and I’ve estimated the latter. We know that hours worked were up by a powerful 0.7% m/m for the biggest monthly gain since June. Since GDP is an identity defined as hours times labour productivity this gain in hours is a strong starting point for estimating growth. There were also several activity readings that pointed to strengths in the goods sector.

The same GDP report should release the preliminary estimate of GDP growth in November. So far we have very little tracking information but one-handled Q4 growth is feasible and would continue to point toward economic resilience that has been the envy of many other economies (chart 6).

OTHER MACRO—TIMING ONLY SCROOGE WOULD APPRECIATE!

The rest of the global line-up of calendar-based risk to markets will be pretty light.

The US updates a series of indicators as follows and put your best indicators on Christmas Eve I always say!!

• Housing starts (Tuesday): November’s tally will probably slip again and continue to follow building permits lower.
• Existing home sales (Wednesday): Falling pending home sales (contract signings) will likely continue to drag completed resales lower when November’s estimate lands.
• Consumer confidence (Wednesday): It’s possible that there will be a small improvement given waning gasoline prices and strong job markets as mitigating factors to rising concern toward the economic outlook.
• Q3 GDP (Thursday): No further revisions is expected to the second estimate that registered growth of 2.9%. This third and final estimate incorporates fuller information on the services sector.
• Jobless claims (Thursday): Was the 20k drop to 211k the prior week a fluke as claims returned to their lowest since September?
• PCE inflation (Friday): In the wake of the soft CPI report for November, the Fed’s preferred measures of inflation are likely to record soft changes of about 0% to +0.1% on headline PCE and core PCE gauges.
• Spending and incomes (Friday): Strong wage gains and resilient job growth could pop income growth materially higher but the previously soft retail sales report suggests total consumption growth may register little to no nominal growth.
• New home sales (Friday): Falling model home foot traffic is a decent proxy for what to expect to happen by way of an expected decline in new home sales during November.
• Durable goods orders (Friday): Boeing’s plane orders from US airlines plummeted to basically nothing last month and should weigh down on total durable goods orders, but core orders ex-defence and air will be shooting for the 9^th gain in 11 months so far this year.