Weekly global economic update
What’s happening this week in economics? Deloitte’s team of economists examines news and trends from around the world.
Asset prices respond to new realities
- In recent weeks, there has been a sizable movement in asset prices as investors absorbed new realities regarding the global economy. Those new realities include a stronger than anticipated US economy, more persistent underlying inflation in the United States and Europe, increased likelihood of trade restrictions to be imposed by the United States, and revised expectations about what the US Federal Reserve is likely to do in the coming months.
One consequence of this set of facts is that investor expectations of inflation have risen. The 10-year breakeven rate, which is a measure of investor expectations of average inflation in the coming 10 years, has risen from 2% in early September 2024 to 2.4% recently. This was likely influenced by the very strong employment report that was released for December. It might also reflect expectations of changes in US trade policy.
Changing expectations of inflation have led to changed expectations about policy by the Federal Reserve. The futures market’s implied probability that the benchmark interest rate will not change by the end of 2025 is now roughly 17%, up from about 9% one week ago. In other words, many investors now believe that the Fed is done cutting interest rates. The result was that yields on US government bonds have risen, with the yield on the 10-year bond nearing 4.8%, the highest level since October 2024. In part, bond yields reflect expectations of future short-term interest rates.
The rise in bond yields, combined with increased concern about the US imposing tariffs on other nations, has contributed to the sharp rise in the value of the US dollar. Lately the euro approached US$1.02, the lowest level since October 2022. In addition, the British pound hit US$1.215, the lowest level since November 2023. Other major currencies depreciated against the US dollar as well. For the United States, the upward movement of the dollar could offset other factors contributing to inflation. For other countries, a depreciating currency could be inflationary. However, it will also boost export competitiveness, potentially helpful should US tariffs be imposed.
Finally, the price of crude oil has risen, with WTI crude recently hitting the highest level since August 2024 and Brent crude hitting the highest level since October. Prices are up roughly 10% since the start of this year. The rise in the price of oil has come despite the rise in the value of the US dollar. Oil is traded in dollars. When other currencies depreciate, their local currency price of oil rises. This puts downward pressure on the dollar price of oil.
However, the dollar price of oil has risen lately largely due to the imposition of new sanctions on the Russian oil sector. This has entailed new sanctions on oil traders, insurers, and operators of tankers. The result is that Indian and Chinese purchasers of Russian oil may face new obstacles. Indeed, it is reported that Indian and Chinese refiners are struggling to find new sources of crude amidst disruption from US sanctions.
Why are short- and long-term borrowing costs diverging in the United States?
- What is especially notable lately is that, in the United States, bond yields have risen even as short-term interest rates have fallen. Since September, the Federal Reserve has cut its benchmark interest rate by 100 basis points. Yet the yield on the 10-year Treasury bond has increased about 100 basis points. Normally, a Fed reduction in short-term rates leads to lower bond yields. That is because bond yields are, theoretically, a prediction of future short-term rates. Why this divergence? There are several possible explanations.
First, investors seem to have upwardly revised their expectations for inflation and Fed policy interest rates based on proposed policies of the new administration such as tax cuts, tariffs, and immigration restrictions. Thus, when investors expect future short-term rates to be higher than previously anticipated, they push up bond yields. Moreover, the rise in bond yields suggests that some investors are betting on the possibility that monetary policy will be tightened.
Second, investors might be worried that the United States will not be able to address its yawning budget deficit, which is now above 6% of GDP at a time when unemployment is low while the country is at peace—an unusual situation. Moreover, the incoming administration proposes specific tax cuts but is unspecific about how to cut government expenditures. The fear is that increased government borrowing will eventually be met by reluctant bond purchasers.
Third, the US economy is growing much faster than previously anticipated, likely leading to increased demand for credit, thereby boosting borrowing costs. Finally, there is a fear that foreign purchasers of US debt, including central banks, will sell US treasuries and diversify their portfolios, especially if central banks want to boost their currencies in the face of a strengthening US dollar.
US inflation surprises in a favorable way
- Investors were pleased recently following US government’s release of inflation data for December. This was despite the fact that headline inflation accelerated in December. Yet that mainly reflected a sharp rise in energy prices. Excluding energy and food, core price inflation decelerated, which is what pleased investors. The result was a decline in bond yields, a drop in the value of the US dollar, and a rise in equity prices. Here are the details.
In December, the consumer price index (CPI) was up 2.9% from a year earlier, the highest rate of headline inflation since July. The CPI was up 0.4% from November to December, the highest monthly inflation since March 2024. The worsening of the headline inflation data was entirely due to the movement of energy prices, which were up 2.6% from November to December. Yet investors are not likely worried about energy prices. Although they were up in December, there are several factors that will likely dampen energy inflation. These include increased US production, weak demand in Europe and China, and China’s rapid transition to electric vehicles.
Meanwhile, when energy and food prices are excluded, the core CPI was up 3.2% in December versus a year earlier, down from 3.3% in November and the lowest core inflation rate since August. Core prices were up 0.2% from November to December, the lowest monthly core inflation since July. This is the news that drove asset prices today.
But there is more. The principal inflation problem in the past year has been the persistence of inflation in services. Prices of goods have been consistently falling. In December, the government reports that service prices were up 4.4% from a year earlier, the lowest annual service inflation since December 2021. The largest component of services is shelter (housing), and the shelter CPI was up 4.6% in December from a year earlier, the lowest shelter rate of inflation since January 2022. Excluding shelter, service inflation in December was the lowest since early 2024. Thus, there appears to be a favorable trend regarding services.
The latest good inflation news led to lower bond yields, with the yield on the 10-year Treasury bond falling by 14 basis points on the day of the release. That, in turn, contributed to a decline in the value of the dollar. For example, the dollar fell nearly 1% against the Japanese yen. Meanwhile, US equity prices were up nearly 2% on expectations that the favorable inflation report will lead to a somewhat easier monetary policy, which would be seen as positive for corporate earnings.
China’s economy: Weak domestic demand offset by strong exports
- According to the Chinese government, the government’s goal of 5% economic growth for 2024 was achieved. The government reported that, in the fourth quarter, real GDP was up 5.4% from a year earlier and up 1.6% from the previous quarter. For all of 2024, real GDP was up 5%. The fourth quarter annual growth was the best in the last 18 months. The government attributed the acceleration to government stimulus measures. However, the data suggests that growth was especially boosted by strong export growth as well as rising industrial production. Retail sales and fixed asset investment both grew slowly, with a continuing sharp decline in property investment. As such, it does not appear that domestic demand was substantially boosted.
The government has lately focused on stimulating domestic demand. It has provided financial incentives for households to replace old electronics and appliances. It has provided financial support to heavily indebted local governments, thereby freeing up funds for local public investment. The hope is that these efforts will pay off in 2025. Yet until now, a disproportionate share of growth came from production and exports of high value-added products such as electric vehicles and solar panels. The problem is that China is likely to face obstacles to further export growth due to trade restrictions imposed by other countries. Already excess capacity is creating deflationary pressure.
Aside from the GDP data, Chinese released data on monthly indicators that provide indications of economic conditions in December. For example, the government reported that retail sales were up 3.7% in December versus a year earlier. This was up from 3% growth in November, but lower than the 4.8% growth in October. By category the biggest growth was in household appliances, up 39.3% from a year earlier. This was likely due to the government’s program of providing incentives for trade-ins. Yet spending on clothing and cosmetics were both up only 0.8% and spending on jewelry was down 1%, suggesting that households shifted their spending to take advantage of the financial incentives. Thus, it is not yet clear whether the government stimulus program is boosting demand or simply shifting the mix of demand.
Meanwhile, the Chinese government reports that, in December, industrial production was up 6.2% from a year earlier, the fastest growth since April. The manufacturing component was up 7.4%, driven by government incentives for production of high value-added products meant for export. Among the categories with strong growth were automobiles (up 17.7%), electrical machinery and equipment (up 9.2%), railway, ship, and aviation (up 10.6%), and computers and communication (up 8.7%). China has clearly become globally competitive in these categories with exports growing strongly. The question is whether this can continue amid protectionist measures by multiple countries. If exports falter, excess supply will likely exacerbate deflationary pressure and hurt corporate margins.
In addition, China’s government reports that, for all of 2024, fixed asset investment was up a modest 3.2% from the previous year, up slightly from the 3% growth seen in 2023. Investment was strong for manufacturing (up 9.2%), but weak for property (down 10.6%). Investment in high tech manufacturing was up 7% while investment in high tech services was up 10.2%. Investment in computers was up 39.5%.
The property sector was a major source of weakness for the economy. Floor space of newly built commercial buildings was down 12.9% from a year earlier in December. The average price of new residential property in 70 major cities was down 5.3% in December from a year earlier.
Finally, China’s exports continued to grow strongly in December. When measured in US dollars, exports were up 10.7% from a year earlier. This was up from growth of 6.7% in November. In part, the strong growth reflects frontloading of exports in anticipation of potential US tariffs. This explains why Chinese exports to the United States were up 15.6% in December versus a year earlier, the fastest such growth since September 2022. In addition, Chinese exports to Southeast Asia were up 18.9% from a year earlier, a record high. The strength of exports to Southeast Asia was influenced by fear of tariffs as China exports intermediate goods to Southeast Asia, which are then assembled into final goods for export to the United States. Overall, exports of steel, automobiles, and household appliances all grew faster than 10% in December. However, automotive export growth has slowed since 2023.
It was also reported that imports were up only 1% in December from a year earlier. Import growth was led by a 12.8% rise in high technology products. It is estimated that, in 2024, net exports accounted for about 20% of China’s economic growth. Given the risk that exports are expected to be constrained once the US potentially imposes new tariffs, economic growth could face new obstacles at a time when domestic demand is growing slowly. Moreover, even in the absence of tariffs, the frontloading of exports implies that export growth will slow down in the months to come.
With exports growing strongly and imports barely growing, China has been accumulating a large trade surplus. In fact, for all of 2024, China’s trade surplus topped US$1 trillion for the first time. Some people see a trade surplus as a sign of economic strength. But it is usually a reflection of weakness. Slow import growth reflects weak domestic demand. Countries in recession often have surpluses. Moreover, surpluses reflect a country saving more than it invests. It means either that households and businesses are saving too much, possibly a reflection of uncertainty about the future, or that there are not adequate domestic investment opportunities. Either way, China would likely be better off if its surplus is reduced. Indeed, the current effort by the government to boost domestic demand will, if successful, lead to a smaller trade surplus.
The relationship between tariffs and currencies
- The US dollar fell sharply against major currencies recently following reports that the incoming Trump Administration might implement fewer significant tariffs than previously expected. Instead, it might seek more limited and targeted tariffs.
During the election campaign, across-the-board tariffs of 10% to 20% were proposed on all imports. Yet it has been reported that some officials in the incoming administration are concerned that this might ignite inflation and hurt consumer purchasing power. Rather, they are considering universal tariffs on a limited selection of goods, with the aim of boosting the competitiveness of key industries that are deemed essential, including output of products that play a role in defense supply chains. Thus, tariffs are being considered on steel, iron, aluminum, and copper. In addition, tariffs are being considered for medical supplies and clean energy products. On the other hand, President-elect Trump denied these reports.
Why did the dollar rise when investors expected high tariffs, and then fall when their expectations changed? Answering this question requires a brief tutorial on the factors that drive trade imbalances: The main reason the United States has a trade deficit is that the country invests more than it saves. When this happens, it means that there must be a net inflow of foreign capital. To facilitate this, foreigners must accumulate more dollars than they spend. That, in turn, implies that the US imports more than it exports, which means a trade deficit. When the United States imports more than it exports, foreigners accumulate excess dollars. All they can do with these dollars is invest in dollar-denominated assets such as US stocks, bonds, and property.
If the United States imposes tariffs, this will initially lead to a decline in imports, thereby reducing the trade deficit. Yet so long as the United States invests more than it saves, it must have a trade deficit. Thus, the dollar must appreciate to boost imports and reduce exports, thereby increasing the trade deficit. Indeed, when investors expected high tariffs following the US election, the dollar appreciated in anticipation of tariffs.
The bottom line is that if the intention of the incoming administration is to reduce the trade deficit, tariffs will not make it happen. The only was to reduce the trade deficit is to boost savings (perhaps by reducing the budget deficit) or cut investment (perhaps by engineering a recession). Notably, the incoming administration recently lauded the intention of a Japanese investor to boost investment in the United States. Yet if there is going to be more foreign investment in the United States, then there will have to be a bigger trade deficit.
In any event, the reports that the incoming administration will be less aggressive about tariffs also suggest less inflationary pressure than previously expected. Tariffs are a tax on imported products that lead to higher prices, thereby fueling inflation. Fewer tariffs mean less inflation, thereby implying that the Federal Reserve can be more aggressive about cutting interest rates. This should lead to a drop in bond yields.
Meanwhile, it was later reported that the incoming US administration is considering declaring a national state of emergency upon taking office. Under US law, this would enable the administration to quickly implement significant tariffs, even against Mexico and Canada where trade relations are currently covered by the USMCA (US Mexico Canada Agreement). This action could be done under the International Economic Emergency Powers Act. Under normal circumstances, a president can impose tariffs under various scenarios that require justifications and periods of review. It normally takes time before a new tariff can be implemented. Under a national emergency, tariffs would take effect quickly. This report suggests that the administration intends to take an aggressive stand on trade relations.
In response to the report about a potential national emergency, the value of the US dollar surged against the euro, the British pound, the Japanese yen, the Canadian dollar, and especially the Mexican peso. Also, the price of crude oil fell sharply due to the rise in the value of the US dollar. Oil is mostly traded in dollars, and thus a rise in the value of the dollar means an increased price of oil in other currencies. Thus, barring changes in supply and demand conditions in the oil market, this leads to a drop in the dollar price of oil.
US job market remains strong
- The US job market continues to surprise on the upside. The government reported job growth for December. It was stellar. The only potential negative is that the government will provide revisions to 2024 jobs data next month. There is an expectation that job growth will be downwardly revised when the government releases its periodic revisions. Still, it is likely that the overall level of job growth last year was favorable, indicative of a strong economy. Let’s look at the details for December.
The US government releases a jobs report that is based on two surveys: a survey of establishments and a survey of households. The establishment survey found that, in December, 256,000 new jobs were added from the previous month. It was the strongest job growth since March 2024. For all of 2024, employment grew by 186,000 per month. This is faster than the job growth that took place in 2019 just prior to the pandemic. Even if there is a downward revision next month, it is likely that 2024 job growth was at least typical of the pre-pandemic period.
In any event, the favorable news for December was greeted with hesitation by investors. It implies potential inflationary pressure, thereby compelling the Fed to keep monetary policy tighter than otherwise. In response to the jobs market news, bond yields increased while the value of the US dollar surged. The Japanese yen hit the lowest level since July 2024. The euro hit the lowest level since November 2022. It is reported that some analysts expect the euro to hit parity with the US dollar this year. Equity prices fell sharply in response to fears of higher borrowing costs in 2025. The decline in equities was led by financial services and real estate companies that are interest sensitive. In addition, tech companies fell sharply.
By industry, employment fell in manufacturing and grew slowly in construction. There was strong growth in retailing, professional and business services, health care, leisure and hospitality, and state and local government. There was weak growth in other industries.
The establishment survey also provided data on average hourly earnings, which were up 3.9% in December from a year earlier, down from 4% in November. While this is above inflation, it is clear that wage growth is not accelerating and might be weakening. Moreover, although the Fed has been concerned about labor market tightness driving up wages, it has also noted that labor productivity growth has helped to offset the inflationary impact of rising wages. For households, wage increases above the rate of inflation mean increased purchasing power.
Finally, the separate survey of households found that employment grew slightly faster than the size of the labor force, thereby leading to a small decline in the unemployment rate, which is now 4.1%, down from 4.2% in the previous month. Youth unemployment dropped especially sharply.
- In November, for the second consecutive month, the job openings rate in the United States increased from the previous month. The job openings rate is the share of available jobs that go unfilled because potential employers have not found people to fill them. It is an indicator of the tightness or looseness of the job market. The US government’s Job Openings and Labor Turnover Survey (JOLTS), which was recently released, indicates that the US job market remains relatively tight and is getting tighter.
The job openings rate increased from 4.7% in October to 4.8% in November. The last time it was higher was in May 2024. Recall that, in the aftermath of the pandemic, the job openings rate had soared to an historic high of 7.4% in March 2022. Since then, it was mostly on a downward trajectory as increases in labor force participation and immigration eased the shortage of labor. Yet prior to the pandemic, the highest job openings rate on record was 4.8%, the same as in November 2024. Thus, even though job market tightness has eased in the past two years, the market remains historically tight.
In response to the news on job openings, bond yields increased to the highest level since May. Investors evidently believe that the US economy remains very strong, thereby creating a risk of inflationary pressure. That, in turn, suggests a cautious approach on the part of the Federal Reserve. Hence, high bond yields. Indeed, the futures market’s implied probability that the Fed will keep the benchmark interest rate unchanged in January is now more than 95%. This is up from 63% one month ago. Moreover, the market is now expecting only one interest rate cut in 2025.
Regarding the job openings rate, it varies by sector. In November, the highest job openings rates were in professional and business services (7.6%), health care (6.2%), financial services (5.8%) and accommodation and food service (5.6%). The lowest job openings rates were in wholesale trade (2.5%), manufacturing (3.1%), construction (3.2%), and retailing (3.3%).
Federal Reserve signals a pivot in monetary policy
- The Federal Reserve has released the minutes from the policy committee meeting that took place in mid-December. Recall that it was at that meeting that the committee chose to cut the benchmark interest rate by 25 basis points. More importantly, the committee signaled a likelihood of a more gradual approach to monetary policy easing than had previously been expected. The minutes confirm this. It said that the committee agreed to a “careful approach” to cutting interest rates.
The committee members also alluded to potential changes in policy on the part of the incoming administration as creating inflationary risk. Specifically, the minutes said that “participants expected that inflation would continue to move toward 2 per cent, although they noted that recent higher-than-expected readings on inflation, and the effects of potential changes in trade and immigration policy, suggested that the process could take longer than previously anticipated.” It also said that the “likelihood that elevated inflation could be more persistent had increased.”
These comments were not a surprise to investors. However, they do confirm that, in December following the election, the Fed chose to effectively pivot toward a different trajectory. Since the election, not only have expectations of policy shifted, but economic data has remained far more robust than previously expected. Thus, even absent policy changes, it is likely that the Fed would have chosen to pivot to a more gradual approach to monetary policy easing. As of now, futures markets are pricing in just one interest rate cut in 2025.
Eurozone inflation accelerates
- As expected, inflation in the 20-member Eurozone accelerated in December for the third consecutive month. This was largely due to a rebound in energy prices. When volatile food and energy prices are excluded, core price inflation remained steady, unchanged for the past four months. Although it is widely expected that the European Central Bank (ECB) will cut the benchmark interest rate again this month, there is concern that the deceleration of inflation is stalling. If so, that might change the trajectory of monetary policy in the months to come. Let’s look at the details.
In December, the consumer price index (CPI) in the Eurozone was up 2.4% from a year earlier. This compares to inflation of 2.2% in November, 2% in October, and 1.7% in September. The December inflation was the highest since July. However, energy prices were up 0.1% in December versus a year earlier, having declined in each of the preceding three months. Thus, when volatile energy and food prices are excluded, core prices were up 2.7% in December versus a year earlier, the same as in each of the preceding three months.
Most notable was the continued divergence between inflation for goods and inflation for services. The price index for non-energy industrial goods was up a very modest 0.5% in December versus a year earlier. Meanwhile, the price index for services was up 4% in December versus a year earlier, nearly unchanged since November 2023. It is this persistence of services inflation that has been a concern for the ECB. Still, the ECB has cut rates several times, clearly concerned about the weakness of the Eurozone economy and evidently confident that inflation is not getting worse. However, it is not entirely clear how fast the ECB will cut rates going forward. In response to today’s inflation data, Eurozone bond yields were relatively stable. This means that investors were not surprised, nor did they shift their expectations regarding monetary policy.
Inflation varied by country. The data indicates that annual inflation in December was 2.8% in Germany, 1.8% in France, 1.4% in Italy, 2.8% in Spain, 3.9% in the Netherlands, 4.4% in Belgium, 1% in Ireland, 2.9% in Greece, and 3.1% in Portugal.