China’s recovery may mean that the Fed will have to raise rates for longer

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SHANGHAI, CHINA — Tourists pose for a photo at the Shanghai Disney Resort as the resort ushered in a month of festivities from January 13 to February 10 to celebrate the upcoming Chinese New Year.

Chinese news service | Chinese news service | Getty Images

With the end of China’s tight Covid restrictions accelerating the country’s economic recovery, concerns about pent-up Chinese demand – and the inflation that may follow – could spell bad news for the US Federal Reserve.

Economic data suggests that the Fed’s aggressive rate hikes are pushing down US inflation, but Chinese demand could return commodity prices to early 2022 levels before the US Federal Reserve embarked on its rate hike journey to ease inflationary pressures. Reduce.

“In our view… a stronger China increases the likelihood of a stubbornly aggressive Fed,” said Tavis McCourt, institutional equity strategist at Raymond James, in his Outlook 2023.

“With China, we need more of everything — if that stimulates enough demand to bring commodity prices back closer to last year’s levels in the spring, then that puts the progress we’ve seen on inflation in a much weaker position. position,” he said.

As activity from China is expected to pick up, demand for a variety of commodities will increase, McCourt said.

“As consumers are allowed to leave their apartments and become more mobile, there will be more demand for gasoline and jet fuel,” he said. “The question will come back very soon.”

Indeed, commodity prices have risen significantly since December, when China announced plans to lift some of its strictest Covid measures.

Three-month copper futures traded on the London Metal Exchange at $9,436 on Thursday morning – up about 12.5% ​​since today’s month. Aluminum prices also rose 11.7% in January, FactSet Data showed.

In fact, Fed officials have expressed concern about the Chinese economy as a factor that could reverse its efforts to dampen inflationary pressures in the US economy.

SHANGHAI, CHINA – JANUARY 15: Travelers crowd at the gates and wait for trains at Shanghai Hongqiao railway station during the peak travel for the upcoming Chinese New Year holiday on January 15, 2023 in Shanghai, China.

Kevin Frayer | Getty Images News | Getty Images

James Bullard, president of the St. Louis Fed, said China’s reopening, combined with a lower likelihood of a recession in Europe, could accelerate inflation again.

“They’ve abandoned their Covid-zero policy and are moving toward a faster reopening of China than previously anticipated, so that sounds like renewed upward margin pressure in global commodity markets,” Bullard said at a roundtable hosted by the Wall Street Journal on Wednesdays.

“I’m nervous that this will lead to upward pressure on inflation in general – that’s a risk we need to consider when setting monetary policy,” he said. “Some of the factors that have been in favor of the 2022 passing narrative can be reversed here,” he said.

“Limited Spill Effects”

China’s reopening may cause inflation, but the spillover effects on the global economy could be limited, according to Morgan Stanley.

“If the recovery [in China] is driven more by consumption rather than investment, we see limited spillovers to inflation in the rest of the region,” the company’s economists, led by Asia chief economist Chetan Ahya, said in a Wednesday report.

“Global supply and demand of goods are more important, and as global demand for goods continues to deflate, this will further limit any spillover effects on inflation in the region,” they said.

One analyst said commodity prices may have “exploded”, but he doubts that will continue.

“Aluminum prices have really exploded in recent months, on the same speculation … regarding China’s reopening,” said Wolfe Research’s director Timna Tanners on CNBC’s “Street Signs Asia.

“We definitely question whether it’s sustainable or supported by the data, but it’s hard to fight some of this momentum in the reopening of trade,” she said.

“We don’t necessarily think there’s going to be a huge activity spurt in consumption or aluminum, but again, if the market thinks that, and inventories are low and there’s some replenishment for Chinese New Year, the momentum has been really strong.” .”

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