Brace for impact of US rate rises and China’s economic moves
Decisions made in Washington and Beijing will have knock-on effects around the world, which many countries will find hard to handle
China’s economic heft means any economyboosting measures that Beijing rolls out will have ramifications for US dollardenominated commodity prices. But never more so than when, as now, commodity prices are already high, driven by a global post-pandemic economic rebound and, more recently, by supply reorientations occasioned by Western reactions to Russia’s invasion of Ukraine.
Add in tighter US monetary policy, which ordinarily enhances the dollar’s allure to investors, and alarm bells should start to ring.
No one should be under any illusions. The decisions made in Beijing and Washington in regards to the Chinese and US economies will have knock-on effects worldwide, which many countries will find hard to handle.
China remains wedded to its zero-Covid policy and is equally determined to use its fiscal and monetary toolbox to mitigate the economic impact of containment measures. Data released on Saturday showing China’s official manufacturing purchasing managers’ index at 47.4 in April underlines the gravity of the situation.
It is against this backdrop that the unveiling of new infrastructure investment plans last week by the Central Financial and Economic Affairs Commission, after a meeting at which President Xi Jinping presided, should be viewed.
Meanwhile, in the United States, more evidence of rising prices emerged in data showing an increase of 6.6 per cent in March year on year in the personal consumption expenditures (PCE) price index, the biggest jump since January 1982.
Given that the Federal Reserve typically pays close attention to PCE data, and with that figure way above the Fed’s target of “inflation that averages 2 per cent over time”, the US central bank looks poised to raise interest rates by 0.5 percentage point today. Further increases will surely follow.
The upward trajectory of US interest rates, especially when local conditions elsewhere mean other central banks are taking a less hawkish approach or remain committed to an ultra-accommodative monetary policy, has supported the dollar on the foreign exchanges in recent months and should continue to do so.
The ebb and flow of market sentiment will prompt periodic dollar sell-offs but the general “bid” tone underpinning the currency should persist, not least against the yen.
Despite the yen hitting a 20-year low against the dollar last week, the Bank of Japan reiterated on Thursday its commitment to its ultraaccommodative yield curve control policy.
There is some concern at Japan’s Ministry of Finance over the pace at which the yen has been weakening, but nevertheless, the currency markets can still conclude that the ministry’s capacity to affect the situation is limited by a central bank yield curve control policy that presently lends itself to yen weakness in general and against the dollar in particular.
Such a conclusion could well lead markets to exploit the yen as a funding currency, selling it against higher-yielding currencies or even selling the yen for commodities to capitalise on rising commodity prices.
In a league table of currencies, this scenario favours the dollar first and Japan’s currency last, with the yuan in between, as Beijing seeks to keep the renminbi competitive against the yen.
But the knock-on effect of China’s new infrastructure investment plan then also comes into play. That plan can only result in increased Chinese demand for already highly priced dollar-denominated commodities.
As those dollar-denominated commodity prices go yet higher, the result will be a weaker greenback against those commodities, even as the dollar outperforms on the currency markets.
That is a real dilemma for countries whose currencies are weakening against the dollar but which must still source dollars to buy increasingly expensive commodities.
But even higher dollar-denominated commodity prices may yet transpire with China ramping up infrastructure investment, the Fed embarking on US interest rate increases and markets having the option of the yen to fund speculative trades that seek to capture such price action.
This scenario favours the dollar first and Japan’s currency last, with the yuan in between