Monday, September 14, 2015

China and the Fed

China activity and financial data for August was a mixed bag with some promising signs that policy easing is starting to have an impact but with the important activity indicators still on the weak side. 

In summary:
  • Inflation blipped higher to 2.0% for the year to August although this reflected higher food (pork) prices.  Non-food inflation came in at 1.1% and producer prices remain in deflationary territory at -5.9%.  Inflation is certainly no barrier to further easing.
  • Exports were a bit stronger than expected but imports were weaker.  The trade data is nominal so lower commodity prices helps explain the weakness in imports.
  • Monetary easing is having an obvious impact on money supply and credit growth.  M3 growth is well off its lows and credit growth came in stronger than expected.
  • However that is yet to be reflected in stronger real activity.  Industrial production came in at 6.1% for August, up on the 6.0% in July but short of expectations of 6.4%.  Weak industrial production is likely to reflect, at least in part, factory shut-downs for the Victory Day World War II commemorations.
  • Fixed asset investment slowed further with stronger infrastructure investment insufficient to offset further weakness in the property sector.  While residential property prices and sales have stabilised recently it will be some time before the existing oversupply is worked through, especially in the second and third tier cities.
  • Retail spending was a bright spot rising 10.8% over the year, up from 10.5% in the year to July.

So there are some signs that the policy easing to date is starting to have some impact but the transmission to the real economy remains slow, hampered by temporary factory closures and continued spare capacity.  That simply confirms once again that real interest rates remain too high and further easing is warranted.

So what’s the Fed to make of all of this?

Recent US labour market data has more than met the Fed’s requirement for some further improvement.  As I said last week, if the Fed’s decision was just about the labour market they would be hiking this week.

However it appears likely the Fed will delay the most anticipated US interest rate hike ever.  Global uncertainties are simply too high and the China data yesterday didn’t bring any clarity, either way.  And while the Fed will continue to see the dis-inflationary impact of lower commodity prices and the stronger US dollar as transitory, they do buy time.

That seems to me to leave three options for the Fed this week.  With their associated probabilities they are:

  1. No hike with a dovish commentary saying the outlook for the world has deteriorated and there is no chance of a rate hike anytime soon. (10%)
  2. A dovish hike i.e. raise interest rates but signal this is it until there is more certainty about the global outlook.  (30%)
  3. No hike but signal they are getting closer which leaves October and December on the table for "lift-off". (60%)


So it’s likely the Fed will delay lift-off.  But I have considerable sympathy for the view put forward recently by the Senior Deputy Governor at the Indonesian central bank that the Fed should raise rates sooner rather than later and end the uncertainty.   Looks like the uncertainty is going to linger a bit longer.