China will Export Disinflation, not Inflation, despite New Stimulus
The last thing the world needs right now is another source of inflation, so China’s stimulus announcement last Tuesday was met with consternation in some quarters. But we think China will be a source of lower, not higher, inflation this year. The new Chinese stimulus package—as it currently stands—should further reduce price pressures.
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As a starting point, consider the outlook for Chinese PPI inflation, the single best guide to export prices.
We expect to see rapid deceleration, driven largely by base effects in industrial metals and oil—as implied by futures curves—pushing PPI inflation down to around 3% year-over-year by the end of 2022, from 8.0% in April. This implies a similar slowdown for export price
inflation, as shown below.
In addition to the expected slowdown in PPI inflation, currency weakness should also help export disinflation to the rest of the world. The renminbi is now depreciating, year-over-year, and even if it were stable from here, base effects alone would mean a growing disinflationary effect over H2. But we expect further weakness—as discussed here—which should see Chinese exports some 5-8% cheaper for dollar buyers, year-over-year, by year-end, all else equal.
As for stimulus, the measures announced last week were largely supply-side in nature, focused on supporting production, rather than boosting demand.
This has been the theme for 2022. Tax and fee cuts for SMEs and manufacturers formed a key pillar of the March NPC, alongside the usual talk of infrastructure spending. Markets by now should already be pricingin the infrastructure story, so we expect no substantial shift in raw material prices, which might otherwise shift the PPI trajectory.
The supply-side measures, meanwhile, will result in higher production at lower cost, and the lack of support for households minimises the chances of China’s labour market following the U.S. path. China is, in fact, battling relatively high unemployment at the moment, so wage pressures are unlikely to be a problem. Absent any meaningful stimulus for domestic demand, this extra, and cheaper, output will seek a market overseas. This should exert further disinflationary pressure on export prices, even if it also risks reigniting trade conflicts.
The bigger inflationary threat stems from China’s zero-Covid policies, and the disruption they bring to supply chains, at home and abroad. This remains unpredictable, but we know that zero-Covid is not going away. Local governments, however, are under pressure to balance zero-Covid with growth.
This implies a less stringent immediate response to outbreaks, at the risk of a repeat of the situation in Shanghai for the last two months. Further lockdowns, and disruption, seem inevitable. But stimulus, at least, is not a reason to worry.
That makes good sense except for the prominent example of oil, which may run higher with rising Chinese mobility.
But there is another reason to be concerned about China and it is not in China at all. It is in the US. Morgan Stanley:
Our analysis shows why we expect the Federal Reserve will be able to slow aggregate consumer demand through policy tightening. Consumption accounts for 70% of US GDP, so tighter policy has significant implications in our US economic outlook.
We examine the drag from higher interest rates on consumption and discuss the likely channels of transmission, including changes in the cost of borrowing, wealth,and income. Our work also highlights an increase in income and consumption inequality from policy, with aggregate data masking an outsized effect on lower-income cohorts.
Using empirical evidence from structural models, we quantify the likely size and timing of effects on personal consumption expenditures (PCE) over a five-year window. Higher borrowing costs for durable goods and housing exert the greatest effect immediately following rate increases, while over the medium term, the lagged response from income and wealth
likely weigh further on household spending.
Our baseline view is for 300bp of tightening through the federal funds rate through 1Q23, before holding steady at 3.125%. Relative to no policy tightening, we estimate that policy path lowers the level of real PCE by 1.0% over the 2022-2023forecasthorizon,all else equal.
Monetary policy affects the economy with long and variable lags. While most of the effect on consumption occurs over the first two years, even with no further interest rate increases consumer demand is depressed for several years beyond our forecast horizon. This dynamic highlights that monetary policymakers are likely to consider both past and prospective increases in the federal funds rate at upcoming meetings.
This is a trade shock in the making, amplified by the enormous US inventory pile which will run down.
The Chinese domestic recovery will be weak on COVID and property and now even more so as trade growth dries up from the US and Europe.
A lower CNY is still the base case and markets hate that.
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.
He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.
