A report by CYS Global Remit Strategic Sales Management Team
Fed Pivot Finally on Horizon | skip to SGD/CNY
A report released by the U.S. Department of Labour last Thursday showed that the U.S. CPI increased by 3.7% y/y in September, slightly higher than the expected 3.6%. The U.S. core CPI increased by 4.1% y/y in September, in line with expectations. Inflation remains high, leading market participants to wonder whether the Federal Reserve will still raise interest rates to combat inflation.
The next FOMC meeting will be held on October 31 and November 1. Since the September FOMC meeting, U.S. inflation has rebounded very clearly, but now the primary determinant of the Fed's monetary policy is no longer inflation. Based on the information released by the Federal Reserve, the capital market has begun to believe that the continued rise in U.S. long-term Treasury bond yields may bring this round of interest rate hikes to an abrupt end.
Senior Fed officials have said in recent days that if long-term rates remain near recent highs and inflation continues to cool, an increase in short-term rates is complete. The rise in long-term Treasury yields began after the Federal Reserve raised interest rates in July and accelerated after the September Fed meeting.
The Federal Reserve raised the benchmark federal funds rate from 5.25% to 5.5% in July, a 22-year high. In September, the Fed paused raising interest rates but said it would raise rates at one of its final two meetings of the year.
The Fed raises interest rates to combat inflation by slowing economic activity, and the main transmission mechanism is through financial markets. Higher borrowing costs lead to weaker investment and spending, a dynamic that is reinforced when higher interest rates also affect stock and other asset prices.
The most obvious outcome right now is that if the 10-year Treasury yield continues to climb to its highest level since 2007, it may displace further increases in the Fed's funds rate. The Fed initially attributed the rise in long-term rates to better economic news. That prompted bond investors to reduce their bets that a recession would prompt the Federal Reserve to lower interest rates in the first half of next year.
But rising interest rates appear increasingly driven by factors that cannot be easily explained by the economy or the Fed's policy outlook. This suggests that the so-called long-term premium, the extra yield investors require to invest in long-term assets, is rising.
Dallas Fed President Lorie Logan, a voting member of the Fed's rate-setting committee, said last Monday: "If long-term rates continue to rise due to rising long-term premiums, then the need to raise the Fed's funds rate may decrease." Logan's remarks are consistent with a notable shift for Fed officials, who had previously been leading advocates of raising interest rates this year.
The term premium of bonds is difficult to measure accurately. Lorie Logan said that at least half of the increase in long-term Treasury yields since the end of July reflects higher long-term premiums.
Federal Reserve Vice Chairman Philip Jefferson also said last Monday that when deciding whether to raise interest rates again this year, it will "continue to recognize the tightening of financial conditions by raising bond yields."
San Francisco Fed President Mary Daly said two weeks ago that the rise in U.S. Treasury yields since Fed officials last met was roughly equivalent to a quarter-percentage point increase in the Fed's short-term interest rates. "If fiscal conditions, which have tightened significantly over the past 90 days, remain tight, our need for further action will diminish," she said.
Comments from Federal Reserve officials indicate that they will not raise interest rates in November, but they need to confirm the economic and financial development in November before deciding whether to raise interest rates in December.
Even if the Fed completes raising interest rates, it is unlikely that Fed officials will formally announce a halt to rate hikes. After all, the Fed has repeatedly surprised itself with the economy's resilience and is more willing to leave the door open to further rate hikes.
By December, the Fed will be able to see whether the recent tightening in financial conditions persists and whether recent progress in inflation continues. Some officials may be less concerned that strong economic activity, such as surprisingly strong employment, could prevent inflation from falling if higher long-term rates persist.
At this juncture, we opine that the change in rhetoric (i.e., interest rate policy languages) from Fed officials is something that the USD bears will be watching very closely. We see a pullback in the USD, as bullish momentum will likely fade following the release of firmer-than-expected US CPI prints.
China CPI Stays Flat
Data released by the data released by the National Bureau of Statistics showed that in September, the consumer market continued to recover, and the consumer price index (CPI) continued to rise m/m. However, affected by the higher comparison base in the same period last year, the y/y increase turned flat. 
Statistics show that CPI increased by 0.2% m/m, and the increase dropped by 0.1 percentage points from the previous month. From a y/y perspective, CPI remained flat from a 0.1% increase last month. On average from January to September, CPI increased by 0.4% compared with the same period last year.
In terms of food, the market supply is relatively sufficient before the Mid-Autumn Festival and China’s National Day this year, and the food price increase is slightly lower than the historical average for the same period. Specifically, as the school season and the Double Festival are approaching, the prices of fresh vegetables and eggs have increased by 3.3% and 3.2% m/m respectively. After the fishing moratorium, supply has increased, and the prices of shrimps, crabs, and seawater fish have dropped by 2.6% and 0.8% m/m respectively. Prices of food, poultry, and meat are stable.
Looking forward to the fourth quarter, Wu Chaoming, deputy director of the Financial Information Research Institute, told a reporter from Times Weekly that domestic demand has picked up, service prices have risen, and energy prices have shifted from being a drag to a pull, all of which have supported the m/m improvement in CPI. However, the drag on pork is difficult to eliminate in the short term. Resident demand is still insufficient. "CPI is expected to rebound overall in the fourth quarter, and is expected to hit 1% in December, with an annual growth rate of approximately 0.5%."
We look forward to a recovery in investments within China to drive growth. One reason for the weakness in state-owned and private investment in the first half of 2023 is that inventories of industrial companies were at historically high levels at the end of 2022. Unlike the United States, China has not transferred cash to households during the pandemic. But to support household incomes indirectly, the government has cut some business taxes while discouraging companies from laying off workers. As a result, often, production continues while sales decline, inevitably leading to record inventories.
Short-term incentives to invest in expanding manufacturing capacity are weak in the first half of 2023 due to record inventories. However, the decline in inventories in the first half of the year may have laid the foundation for increased investment in the future.
During the epidemic, private investment continued to expand, but the expansion rate slowed down relative to state investment. In the first half of 2023, private investment shrank by 0.2% for the first time. But private investment still accounts for more than half of total investment, suggesting that private property rights have been eroded less than some critics claim. Strengthened supervision of Internet companies and real estate adjustments are two important factors leading to the relative slowdown in private investment.
First, the government's sudden crackdown on Internet platform companies, the vast majority of which are private enterprises, caused a significant reduction in their revenue, investment, and hiring starting in late 2020. But in July 2023, the regulatory authorities sent a clear signal, saying that problems in the financial activities of Internet companies had been “rectified.” Companies such as Alibaba, ByteDance, and Meituan-Dianping have responded by increasing their recruitment of new employees, reversing the wave of layoffs experienced by these and other private technology companies in 2022. Under the "new normal regulation" system, their profitability may not be as strong as before, but it will certainly be higher than the low levels from 2022 and the first half of 2023, thus boosting overall private enterprise investment growth.
Secondly, real estate investment fell by 10% y/y in 2022 and by a further 8% in the first half of 2023. Before the correction, private companies accounted for most of the real estate investment. Therefore, the decline in real estate investment has a greater impact on the overall level of private investment. Private real estate companies are now deleveraging and are unlikely to resume investment other than trying to complete pre-sold but unfinished projects. Therefore, real estate will continue to be a drag on the rapid growth of private-sector investment.
China has suffered huge losses during the epidemic, and the economic recovery after the epidemic has currently fallen short of expectations. The above analysis shows that the economic recovery may have begun, but it is still fragile. Time will tell whether China's economic recovery has taken off or whether it is entering a cyclical downward spiral.