Weekly global economic update

Week of December 23, 2024

• China’s economy continues to exhibit weakness
• US Federal Reserve shakes markets
• US retail sales remain robust
• UK inflation accelerates while the Bank of England pauses

China’s economy continues to exhibit weakness

• New economic data from China signals that the weakness of domestic demand persists. This has been a prime concern of the government as it seeks to restore stronger economic growth. China has lately faced a series of headwinds that have led to slower growth. These include the problems in the residential property market, a loss of household wealth due to a decline in home prices, weak consumer spending, and weak private sector investment. These problems have been exacerbated by onerous demographics, with a decline in the working-age population and a halt to the internal migration that previously had boosted productivity. Moreover, China faces potential constraints on its ability to grow through exports.

In the past few weeks, the government has signaled an intention to provide fiscal stimulus meant to boost domestic demand. The latest data will likely provide further evidence that such action is needed. Yet so far, most of the actions taken by the government were meant to boost equity prices or resolve debt problems for local governments. Many economists believe that what is needed is direct support for households.

Let’s look at the details of the latest data.

In November, Chinese retail sales were up only 3% from a year earlier, much slower than the 4.8% growth seen in October. It was the slowest growth of retail sales since August. Sales were down 26.4% for cosmetics, down 5.9% for jewelry, and down 4.5% for apparel and textiles. On the other hand, sales were up 22.2% for appliances and audio-visual equipment—although this was much slower growth than in the previous month. Also, retail sales were down from October to November.

Meanwhile, industrial production was up 5.4% in November versus a year earlier. This was marginally better than in October, but far below the growth rates seen in 2023 and early 2024. The manufacturing component was up 6% while utility output was up a meager 1.6%. Within manufacturing, there was strong growth for computers and communications equipment (up 9.3% from a year earlier), automobiles (up 12%), chemicals (up 9.5%), and non-automotive transportation (up 7.9%). In part, this reflects the effort by the government to promote investment in and production of products using high technology. The goal has been to boost exports, which are currently growing strongly. Yet the risk is that protectionist measures by trading partners will limit export growth, thereby exacerbating the excess capacity that is already causing deflationary pressure. Moreover, the recent strength of exports was partly due to frontloading in anticipation of tariffs. This suggests that export growth will slow down in the coming months.

Also, fixed asset investment in China in the first 11 months of the year was up 3.3% from a year earlier, the slowest growth since December 2023. While investment in property was down 10.4%, investment in manufacturing was up 9.3%. In addition, prices of homes in 70 major Chinese cities fell 5.7% in November versus a year earlier. This was slightly better than the 5.9% drop in October. It was the first time since May 2023 that there was a deceleration in property price weakness. Still, it was the 17th consecutive month in which home prices fell from a year earlier. The drop in property values has hurt household wealth, thereby likely having a negative impact on household willingness to spend. 

In response to these numbers, a spokesman for the government said that “we must further expand domestic demand, stabilize expectations and boost vitality, so as to promote sustained economic recovery and growth, and ensure the successful achievement of major annual targets of economic and social development.” What is not yet known is how the government intends to do this. The weakness of the data led to a further decline in Chinese sovereign bond yields. 

The weakness of China’s economy is already having a spillover effect on some other countries. Resource-rich countries such as Canada and Brazil, which have depended on exporting commodities to China, have seen their currencies depreciate partly due to the weakening of exports to China. These countries have also seen depreciation because of rising bond yields in the United States and the threat of tariffs from the United States.  

US Federal Reserve shakes markets

• As expected, the Federal Reserve’s policy committee cut the benchmark interest rate by 25 basis points recently. More importantly, it signaled a slower pace of interest rate cuts in the coming year than was previously expected. That, in turn, led to a modest rise in US bond yields, a decline in US equity prices, and a sharp increase in the value of the US dollar against other major currencies. The vote by the committee was 11-1, with one member preferring to keep the rate unchanged. 

The members of the policy committee, known as the FOMC (Federal Open Market Committee) offered projections for the benchmark interest rate (the Federal Funds rate) in 2025 as well as for inflation. The median projection for the Federal Funds rate in 2025 was 3.4% when the committee met in September. Now, the median projection is 3.9%. Moreover, this is directly related to a shift in the median projection for inflation (PCE-deflator). In September, the median projection for inflation in 2025 was 2.1%. Today it is 2.5%. Thus, the FOMC members now expect higher inflation in 2025 than previously, thereby necessitating a tighter monetary policy than previously anticipated. The median projection is for only two interest rate cuts in 2025.

The shift in FOMC expectations about inflation are interesting given that the US government released data indicating a further deceleration in wages. The private sector wage and salary component of the employment cost index (ECI) was up 3.8% in the third quarter of 2024 from a year earlier, down from growth of 4% in the second quarter. Moreover, this was the slowest rate of growth of private sector wages and salaries since the second quarter of 2021. The Fed had previously indicated concern about rising wages due to labor market tightness. It had worried that persistent large wage increases were responsible for persistent inflation in services. If wage inflation is decelerating, this suggests good news regarding the future path of inflation.

On the other hand, in his press conference, Fed Chair Powell said, “I think the labor market by many measures is at or nearing normal—but not totally back to normal.” He added that “job openings are not quite back to where they were. Wages—wage increases, rather—are not quite back to where they would need to be in the longer run. I would look at it this way, though. The economy is broadly normalizing, and so is the labor market. And that process will probably take some time. So wage setting is something that happens—[it will] probably will take a couple of years to get all the way back. And that’s okay.” Consequently, he said that the United States has not yet achieved the much hoped for soft landing. That, in turn, suggests that monetary policy should not be too easy.

With wages decelerating, the question arises as to why the Fed now expects higher inflation than previously. One possible reason is that the economy is clearly stronger than FOMC members perceived back in September. Indeed, it was in September that the Fed chose to implement a 50-basis-point rate cut, due to concerns about potential weakness in the economy. A strong economy, with a continued tight labor market, means that inflationary pressure will likely be stronger than otherwise. Thus, a rapid decline in interest rates might exacerbate inflation and prevent it from reaching the Fed’s 2% target.

Another possible reason to expect higher inflation is that the policy mix suggested by the incoming administration might boost inflation. This policy mix is expected to include tax cuts and tariffs, both of which may be perceived as potentially inflationary. However, in his press conference, Powell said nothing about taxes or tariffs, nor was he asked about this.

One factor that could lead the Fed to cut rates faster would be continued strong increases in labor productivity (output per hour worked). A significant rise in productivity in 2024 provided the Fed with room to start cutting interest rates even when labor costs were rising strongly. That is because, when productivity is rising, companies can boost wages without necessarily raising price commensurately. When asked about whether productivity growth will be sustained in 2025, Fed Chair Powell said that “I don’t know.” Indeed, no one knows. Moreover, Powell said that, although generative AI has the potential to boost productivity, this will happen “probably not in the short run—probably, maybe in the longer run.” 

The news from the Fed had a big impact on futures markets. The implied probability that the Fed will hold rates in January was 91.4% after the Fed announcement, up from a probability of 54% one month ago. That shift in expectations largely explains the movement in equity and bond prices during the latter part of last week.

Also, changed expectations about Fed policy are wreaking havoc in currency markets. In Brazil, the currency has fallen to a record low against the US dollar. It has fallen 23% this year. There is concern that the currency will continue to depreciate, thereby fueling increased inflation in Brazil, unless the government takes steps to address fiscal imbalances. In the interim, Brazil’s central bank has been selling dollars in an effort to stabilize the currency. It sold US$6 billion last week and has signaled an intention to sell an additional US$3 billion. It has also sharply increased its benchmark interest rate, the Selic rate. Yet a permanent solution to the weakness of the currency will likely require fiscal reforms, which could be politically difficult and unpopular. As interest rates rise, Brazilian equity prices have underperformed those of other emerging countries. 

Meanwhile, it is reported that China’s central bank, the People’s Bank of China (PBOC), has increased its intervention in currency markets to stabilize the renminbi. The Chinese currency has been under pressure because of expectations of higher US interest rates than previously anticipated, as well as indications that the Chinese central bank will engage in an easier monetary policy in the months to come. In addition, the expectation that the United States will impose tariffs on China has put downward pressure on the renminbi. 

China has several reasons to want to avoid currency depreciation. First, it could be inflationary, although this is not currently a concern given China’s recent flirtation with deflation. Second, a depreciating currency will likely create more tension with the United States. Avoiding depreciation is seen as a way to avoid increased trade tension. Third, China aspires to make the renminbi a major trading and reserve currency. Weakness in the value of the renminbi acts against this goal. 

Clearly, financial markets, as well as central banks, are now making decisions in part based on expectations of a shift in US economic policy. Yet the reality is that there remains uncertainty about the actual policies that will emerge, whether they will be supported by the US Congress, as well as their timing. Moreover, there remains uncertainty as to how other countries will respond should they face increased US tariffs.  

US retail sales remain robust

• In the United States, retail sales grew strongly in November, which might lead to the conclusion that the consumer sector remains strong. However, the strong growth of retail sales was almost entirely due to rapid growth of spending on automobiles. Excluding this, retail sales grew modestly. Here are the details.

In November, overall retail sales (not adjusted for inflation) were up 0.7% from the previous month. In addition, sales were up 3.8% from a year earlier, the strongest annual growth since December 2023. Given that goods prices are now falling, this indicates strong real (inflation-adjusted) growth of retail spending. 

However, spending at automotive dealerships was up 2.6% from October to November and up 6.5% in November from a year earlier. When automotive is excluded, retail sales were up 0.2% from the previous month and up 3.2% from a year earlier. Thus, underlying spending growth was only modestly strong.

One category that saw strong spending growth other than autos was non-store retailing, which is mostly internet-based retailing. This type of spending was up 1.8% from the previous month and up 9.8% from a year earlier. This suggests that the share of holiday spending that takes place online continued to grow in November. Most other categories saw either slow growth or negative growth. For example, from a month earlier spending was down 0.6% at department stores, down 0.2% at grocery stores, down 0.2% at clothing stores, and down 0.4% at food service retailers (restaurants).  

UK inflation accelerates while the Bank of England pauses

• Inflation in the United Kingdom accelerated in November, creating a potential headache for the Bank of England (BOE). The government reported that, in November, consumer prices were up 2.6% from a year earlier, up from 2.3% in October and the highest rate of annual inflation since March 2024. When volatile food and energy prices are excluded, core prices were up 3.5% from a year earlier, the second highest rate since April 2024. The acceleration in inflation was attributed to rising fuel prices as well as rising apparel prices. Meanwhile, inflation in services remained high at 5%, a problem that has afflicted the Eurozone and the United States. With wages rising amidst a tight labor market, and with productivity stagnant, it seems unlikely that service inflation will abate in the near term.

As expected, the BOE left its benchmark interest rate unchanged. The decision by the policy committee was six to three. The majority expressed concern that accelerating wages and prices “added to the risk of inflation persistence.” The decision means that the BOE is focused more on inflation than on economic growth. Indeed, the BOE expects that the British economy will not have grown in the fourth quarter. Moreover, the government is increasing taxes on employment. The BOE, referring to this, said that there is “significant uncertainty around how the economy might respond to higher overall costs of employment.”

Andrew Bailey, governor of the BOE, said: “We think a gradual approach to future interest rate cuts remains right. But with the heightened uncertainty in the economy, we can’t commit to when or by how much we will cut rates in the coming year.” The BOE is caught between concern about inflationary pressure and weakness in the economy. However, it is likely to continue to focus more on inflation. In part, this reflects a need to anchor expectations of inflation. This is an important aspect of central banking. Market expectations of inflation can affect actual inflation. That is, if market participants expect higher inflation, they will likely act in ways that exacerbate inflation—and vice versa. Thus, central bankers try hard to suppress expectations of inflation, both through their actions and especially their words.

Meanwhile, the three members of the policy committee who voted to cut the benchmark rate pointed to “sluggish demand” as a concern. The committee also pointed to external risks, indicating that such risks have increased. This was likely a reference to potential US tariffs. In response to the BOE decision, bond yields fell while the value of the pound fell as well. This likely reflected investor confidence that the BOE policy will lead to lower inflation. That is, the BOE successfully anchored expectations of inflation.

Week of December 16, 2024

• Governments and businesses plan for changes in US trade policy
• US job growth remains strong
• US inflation rebounds slightly

Governments and businesses plan for changes in US trade policy

• As the new US administration takes shape, global political and business leaders are keen to understand the potential impact of new economic policies. However, the particular issue that is top of mind for many is trade policy. The incoming US president has proposed a variety of trade policies, which creates uncertainty about the potential implications on supply chains and prices paid by US consumers. For example, President-elect Trump has proposed across-the-board tariffs of up to 20%, among other measures. The nominee for treasury secretary has suggested that tariffs could be gradually implemented to encourage trading partners to make concessions. On the other hand, some within the incoming administration have said that steep tariffs might encourage reshoring of manufacturing processes in the United States. Still others have said that revenue from tariffs could offset the loss of revenue from tax cuts.

More clarity on these issues is expected after the new administration takes office on January 20th, almost a month from now. However, governments and businesses are continuing to prepare for potential changes. Let’s examine what has been happening.

President-elect Trump proposed 25% tariff on all imports from Mexico, which prompted a phone conversation between Trump and Mexican President Sheinbaum. Comments from both sides that the call was a success led the peso to rebound after having fallen sharply on news about proposed tariffs.

Also, the US Mexico Canada Agreement (USMCA), the free trade agreement negotiated by the first Trump Administration, is set to be renegotiated in 2026. Trump has proposed substantial tariffs on imports from Mexico, including on automobiles and parts from Mexico. Such changes could potentially disrupt the established automotive supply chains in North America. Most cars assembled in the United States include a substantial amount of value stemming from elsewhere in North America and beyond. Also, roughly one quarter of Mexico’s exports to the United States involve transportation equipment.

Trump also proposed a 25% tariff on Canada. Canadian Prime Minister Trudeau implied that, while he favors retention of the three-country agreement, he is willing to develop a bilateral relationship if necessary. He said that “pending decisions and choices that Mexico has made, we may have to look at other options.”

Meanwhile, in anticipation of tariffs, it is reported that exporters in Mexico, Canada, and China have been frontloading exports. Plus, many shippers have already been frontloading exports in anticipation of another port strike in the United States. This has the potential to create new bottlenecks and higher costs. On the other hand, data on inventory accumulation by retailers and wholesalers in the United States suggest that there has not yet been an excessive surge in imports. Moreover, exporters recognize that, even if tariffs are announced under the new administration, it may take time before they are fully implemented. 

• Some leaders in Europe have expressed concern about the potential for reduced trade between the United States and others, which could cause much of the world’s excess capacity to be aimed at Europe. The vice president of the European Commission, Stephane Sejourne, said that “I fundamentally believe that Europe has everything to gain from being open to the world.” But “when China says, ‘Made in China’ or the US says ‘America First,’ we must say: ‘Made in Europe’ or ‘Europe First’.” He added that “if all the world markets close, the only remaining open market cannot be the European market. If the United States closes to Latin America, closes to India, closes to China, the European market cannot be the destination for all the overcapacities in the world, otherwise we will find ourselves in a situation of short-term economic crisis.”  

Sejourne’s comments demonstrate Europe’s perceived vulnerability to potential trade policy changes by other major countries. The EU has been an active participant in the reduction of global trade barriers over many decades, although many barriers remain, even within Europe. Europe has been a strong exporter to the rest of the world, including to the United States and China. Thus, restrictions imposed by either could be damaging to Europe’s economy. Sejourne said that the EU will act to support key industries threatened by foreign competition, but that the EU is not interested in having a trade war. Rather, it wants to be able to compete vigorously in global markets.

• Several central banks have lately taken actions that, in part, were driven by revised expectations about the global economic situation in the wake of the US election. Here is a look at what has happened.

— Recently, the central bank of Brazil increased its benchmark Selic interest rate by 100 basis points. This followed a 25-basis-point increase in September and a 50-basis-point increase in November. Brazil now faces accelerating inflation after a period of stability. In part, this likely reflects a decline in the value of the Brazilian currency against the US dollar, a trend that accelerated after the US election and which leads to rising import prices.  

Moreover, investor expectations for Brazilian inflation have increased as well. Since the US election, the 10-year breakeven rate for Brazilian inflation has increased by roughly 100 basis points. In other words, investors now expect that the expected policy mix of the US government (tax cuts and tariffs) will likely depress Brazil’s currency, thereby boosting average Brazilian inflation by one percentage point during the coming decade. That, in turn, explains why the central bank has taken such drastic measures. The interest-rate increase is likely meant to both fight inflation and stabilize the value of the currency.

— In Switzerland, however, the concern is that potential US tariffs could hurt Swiss exports. Plus, there is a concern that continued easing of monetary policy by the neighboring European Central Bank (ECB) will reduce the export competitiveness of Swiss products in the Eurozone market. Thus, a cheaper Swiss currency is seen as needed. Consequently, the Swiss National Bank (SNB) cut its benchmark interest rate this week by 50 basis points. This followed three 25-basis-point cuts over the last three months.  

Switzerland’s benchmark interest rate is now 0.5%. Moreover, the governor of the SNB recently said that negative rates are conceivable. However, he added that the recent 50-basis-point move makes that less likely. The key issue is the value of the currency and its impact of export competitiveness. Interest rate policy is meant to influence the exchange rate. 

— In Canada, the central bank recently cut its benchmark interest rate by 50 basis points. This took place because of confidence that inflation is moving in the right direction, as well as concern about the weak state of the Canadian economy. However, the size of the cut likely indicates angst over the potential impact of US trade policy. 

The incoming US administration has talked about the possibility of significant tariffs on imports from Canada, as well as tariffs on all imports from all countries. Either way, the impact on Canada would likely be substantial. Aside from retaliatory tariffs, the most likely way to deal with tariffs would be for Canada to suppress the value of its currency, thereby boosting export competitiveness and offsetting the impact of tariffs. Thus, a more aggressive easing of monetary policy can cause a currency depreciation.   

— Finally, the European Central Bank (ECB) cut its benchmark interest rate recently by 25 basis points. Even absent concerns about a change in US policy, it is likely that the ECB would have taken this action. Yet it is likely that ECB leaders are giving thought to the potential impact of US policy on their decision-making. At her press conference, ECB President Christine Lagarde said that the central bank’s baseline forecast assumes no shift in US trade policy. Yet that is not necessarily realistic. 

If the United States imposes significant tariffs on imports from Europe, it will likely lead to a depreciation of the euro. The ECB might also choose to accelerate monetary easing, both to facilitate a depreciation and to boost domestic demand. Moreover, if the United States imposes major tariffs on China, it might lead to an increase in Chinese efforts to export to Europe. That, in turn, might affect the trajectory of ECB policy, especially if the EU responds with restrictions on imports from China.   

US job growth remains strong

• The US job market remains very strong. The latest job market report shows that payroll employment grew at a healthy pace in November. On the other hand, the household survey found that the unemployment increased slightly, although it remains historically low. The US government publishes a jobs report that encompasses two surveys: One is a survey of establishments; the other a survey of households. 

Let’s first consider the establishment survey. It found that, in November, 227,000 new jobs were created. This was far more than the weak October numbers, which were adversely affected by hurricanes and strikes. Yet the November number was less than the stellar performance in September. Still, excluding September, the November increase was the biggest since March. 

This report was the last one before the Federal Reserve’s policy committee meets on December 17–18. At that meeting, it will decide whether to cut rates again. As of now, the futures market’s implied probability of a 25-basis-point rate cut this month is now 85%, the same as it was prior to the election. Recall that, after the election, this probability dropped sharply when investors worried about the inflationary implications of potential policy shifts. Now the probability has returned to the pre-election level, suggesting that investors are not convinced that there will be a quick shift in policy. Moreover, investors have probably taken a signal from comments made by Fed officials indicating a likely rate cut.

From the Fed’s perspective, the environment for interest rate cuts is good. The Fed’s favorite measure of inflation is close to the 2% target. Moreover, although services inflation is too high, driven by rising wages in a tight labor market, labor productivity growth is offsetting the inflationary impact of rising wages. If productivity continues to grow, then there is reason to expect inflation to ease further. Meanwhile, the Fed has expressed concern that persistent high interest rates might eventually weaken the economy. Thus, cutting rates makes sense. Financial market reaction to the jobs report was minimal. 

Meanwhile, there was job growth in many sectors in November. In manufacturing, 22,000 new jobs were created, entirely in non-automotive transportation manufacturing. This reflected the return of workers following the strike at Boeing. In addition, there were 26,000 new jobs in professional and business services, 17,000 new jobs in financial services, 54,000 new jobs in health care, 53,000 new jobs in leisure and hospitality, and 33,000 new jobs in government—almost all in state and local government. On the other hand, there was a loss of 28,000 jobs in retailing. Also, the establishment report found that average hourly wages were up 4% in November from a year earlier, the same as in October. 

Finally, the separate survey of households, which includes data on self-employment, found that the unemployment rate increased from 4.1% in October to 4.2% in November.  

US inflation rebounds slightly

• In November, headline inflation in the United States accelerated for the second consecutive month. Yet this was widely expected. As such, the futures market’s implied probability that the Federal Reserve will cut the benchmark interest rate by 25 basis points this month increased to 95%. This is up from 65% just after the election in early November. Still, although investors are now confident that the Fed will act this month, they are less confident of steady rate cuts in 2025. Rather, there is an expectation that rate cuts will be intermittent, depending on data and policy. This expectation reflects the strength of the US economy as well as concern about the potentially inflationary impact of new policies. 

As for inflation, the consumer price index (CPI) was up 2.7% in November from a year earlier. This was up from 2.6% in October and 2.5% in September. In addition, the CPI was up 0.3% from October to November, up from 0.2% in the previous month. The acceleration reflected an increase in energy prices (which previously had been declining) and an acceleration in food prices. 

When volatile food and energy prices are excluded, core prices were up 3.3% in November versus a year earlier, the same as in September and October. Core prices were up 0.3% from the previous month, the same as in each of the previous three months. Thus, underlying inflation remains steady and significantly above the Federal Reserve’s target of 2%. Once again, the principal reason is the persistence of inflation in services, with prices up 4.5% from a year earlier. Prices of durable goods were down 2% while prices of non-durable goods were up 0.4%. 

The largest component of services is shelter, with prices up 4.7% from a year earlier. When shelter is excluded from the CPI, the overall rate of inflation in November was only 1.6%. Thus, continued inflation in shelter is a major driver of overall inflation. Yet the shelter component of the CPI reflects pricing of housing with a roughly nine-month lag. In the months to come, it will probably decelerate, thereby contributing to lower inflation. 

As for other services, they tend to be labor intensive and labor costs are rising due to the tightness of the job market. On the other hand, labor productivity, especially in services, is rising. This enables companies to pay higher wages without necessarily increasing their prices. If productivity continues to grow at a healthy pace in 2025, this will help to reduce inflation further, thereby providing the Fed with confidence to cut interest rates further.

The biggest remaining question regarding inflation is the potential timing and size of any new tariffs. A tariff is a tax on imports, mostly paid by the people or businesses that purchase the imported product, unless importers are willing to take a hit to their margins. If significant tariffs are introduced, this will almost certainly boost inflation over time. It would likely change the trajectory of Federal Reserve policy as well. There have been conflicting statements about tariffs from representatives of the new administration. Thus, we will have to await greater clarity on trade policy once the new team takes office. Meanwhile, current Treasury Secretary Janet Yellen said that, while tariffs can be useful in addressing unfair trade practices, they could have an “adverse impact on the competitiveness of some sectors of the US economy and could significantly raise costs to households.”