Three important events that could change the global macroeconomic landscape

Financial markets are focusing on the March FOMC to get a clearer picture of the Fed's stance on interest rate and monetary policy. Especially after market expectations for interest rates have changed significantly in just a few weeks: from expecting 6 Fed rate cuts back in January to now only expecting the Fed to cut rates 3 times this year.

But besides the FOMC, in March, two major Far East economies: Japan and China will also go through major events that could change the global economic-geopolitical landscape. The two events in China and Japan include:

• China's 'Two Sessions' meeting, amid the Asian dragon struggling with an economic-financial crisis due to deflation and frozen real estate.

• Japan's Shunto wage negotiations will come to a close: directly determining the BOJ's stance on monetary interest rate policy.

Therefore, Viet Hustler will kick off March with an article analyzing the impact of the above 3 major events, along with predictions on the global economic landscape based on a few possible scenarios at these 3 events.

March FOMC: Last week's PCE report is not enough to change the situation for the Fed

Interest rate policy at the upcoming 03/20 FOMC is expected to hold no surprises: Fed will still keep rates at their peak and deliver the message "wait and observe the economy".

• Currently, the market has gradually pushed back expectations for the first Fed rate cut to June:

  

Meanwhile, last week's PCE (one of the key bases for the Fed to decide on interest rates) shows consumer inflation (y/y) still on a downward trajectory:

Therefore, even though the m/m increase in Core PCE reached the highest level in a year (image below), the market still reacted quite optimistically.

Because in the long term, CPI y/y will catch up with the decline in PCE y/y, as housing costs are the main reason for the divergence between the two indicators:

• CPI assigns >30% weight to housing costs (depending on the time): based on responses from survey participants.

• While PCE assigns only ~17% weight to housing costs: based on actual consumer spending data

  

• Therefore, it will take a few more months for housing CPI (especially rent prices) to accurately reflect the market decline for new lease contracts:

  

From the wholesale price perspective: the downward trend in PPI remains steady across both goods and consumer services groups, with overall PPI still showing negative growth (y/y).

Therefore, both PCE and PPI are confirming the disinflation trend, … but inflation is perhaps not falling fast enough as the Fed expects!

Last week's PCE decline is an encouraging impetus but not strong enough to change the overall situation and the Fed's "wait and observe the economy" stance because:

1. CPI inflation is still declining too slowly:

   • Before the January CPI was released on 02/13, both the market and the Fed expected inflation to drop below 3% for the first time - that did not happen!

     

2. Both CPI and PCE supercore (excluding housing costs) have turned around and increased again

   

Therefore, the Fed emphasized "need to see more evidence" that inflation can return to the 2% target!

• And last week's PCE report, of course, still isn't convincing enough for the Fed.

Although at the March FOMC, the Fed will almost certainly not pivot as the market expected earlier in 2024, this FOMC meeting is quite important because:

• Fed members will convene, discuss, and align on the direction for interest rate policy this year:

  • especially after contrasting views from individual members last week. 

• March FOMC will also come with the Fed's target forecasts for key economic indicators such as:

  • unemployment, GDP growth …

  • dot-plot of FOMC members' opinions on long-term interest rate plans…

Certainly, Viet Hustler will closely report on the Fed's stance after this FOMC meeting.

China: 2024 Annual “Two Sessions” Meeting 

• Content of the 2 meetings: approving laws, economic targets, personnel changes and government budget usage …

The Two Sessions is always an event observed by the whole world: China's important policies are all decided here. For example:

• In 2021, Beijing expanded control over the city (formerly semi-autonomous) Hong Kong.

• In 2020, the Two Sessions passed the Hong Kong national security law (crime extradition law): the origin of the student freedom struggle movement and the heavy-handed suppression by the authorities.

• In 2018, state leadership term limits were abolished => paving the way for Xi Jinping to become “lifelong leader”!

China's Two Sessions this year will take place next week: 03/04 - 03/11.

Two major issues of concern at this year's Two Sessions?

1) Local government debt and public debt issues

• Spending and budget issues are always among the topics discussed at China's annual Two Sessions. 

• Especially when Beijing issued CNY 1,000 billion in ultra-long-term special bonds (announced from October 2023) to fund economic stimulus programs (and is planning another issuance).

  • This issuance has pushed the budget deficit to -3.8% GDP (previously only -3% GDP).

  

• Meanwhile, Fitch estimates LGFV (a type of local government bond) has accounted for 75% of Free Trade Zone (FTZ bonds) issuance since the end of 2022. 

  • FYI: Free Trade Zone - FTZ bonds are typically issued in USD => Making China's Original Sin problem more severe!

  

Therefore, Chinese citizens as well as the financial community may want to know more about how China will spend that CNY 1,000 billion to stimulate demand amid the current deflation…

• … and next, what China will do to resolve local government public debt.

2) What economic growth model for China amid deflation

Premier Li Qiang is expected to set the GDP growth target at the Two Sessions (03/05) at ~5%.

Although still lower than past growth levels, 5% is a quite ambitious target for 2024.

• Tomoo Marukawa (Economics professor - University of Tokyo) predicts China's economic growth will be much lower: from 2.8% (worst case) to 4.5% (baseline scenario).

Challenges for China's 2024 economic growth:

In 2023, despite the financial system collapse after the real estate bubble, China still achieved better-than-expected growth (5.2%)….

… thanks to the rise of new industries like clean energy and electric vehicles (Electric Vehicles - EV) —> figure below.

• FYI: In 2022-2023, after exports of EV, lithium batteries and solar panels abroad rose +29.9% (CNY), China intended to use these three products to boost exports and growth.

  

But the situation oversupply (especially in the electric vehicle industry) + deflation (reduced demand) + trade restriction measures from the US/Europe at the end of 2023 have made China's clean energy and electric vehicle advantages no longer viable...

Currently, China appears to be shifting focus back to attracting FDI and striving at all costs to improve consumption and deflation issues.

Challenges in curbing China's deflation

In reality, deflation (or consumer demand collapse) can hinder growth in any major economy. 

• According to Professor Marukawa: “China's current development level is still lower than Japan's in the 1990s when deflation began”. 

Deflation is always a greater challenge than inflation for central banks: especially as China shows signs of falling into the Liquidity Trap

• The liquidity trap is the situation where the central bank has cut interest rates to 0% or negative and eased monetary policy but still fails to stimulate consumer spending.

• Read more: Liquidity Trap - Central Bank …

Signs of falling into China's Liquidity Trap include:

• Even if PBOC has actually cut interest rates + loosened monetary policy (QE) and introduced a series of economic stimulus packages, causing market yields to drop sharply:

  

• … the people still save more and more instead of consuming.

  

• Consequently, corporate borrowing demand also disappears (simply because consumer demand has decreased), even with cheap capital available.

  

Therefore, economic growth, not only in 2024 but also in the following years, will still be a question and challenge for China.

• Because deflation could last for many years if China truly falls into the Liquidity Trap

Japan: The result of the March Shunto wage negotiations will decide whether BOJ pivots or not

First, why is the monetary interest rate policy of the Bank of Japan (BOJ) important to the global financial system?

• The answer lies in Viet Hustler's old article about BOJ's policies and their global impacts.

For over a decade, BOJ has implemented ultra-loose monetary policy to improve the deflation and low inflation situation.

Currently, Japan has achieved a "desirable" inflation level due to the global inflation wave:

• Japan's January 2024 headline CPI reached +2.2% y/y - higher than forecast +1.9%

• Core CPI at +3.5% y/y (also higher than predicted +3.3% y/y).

  

But whether maintaining a high 2% inflation long-term is possible depends largely on people's income growth (wage-price spiral):

• i.e., the direct factor determining whether people can spend more freely!

Therefore, the Shunto wage negotiations between the Japanese Trade Union Confederation and business representatives will be closely watched by BOJ to determine if inflation is sustainably long-term.

• Last year, the Japanese Trade Union successfully negotiated the highest wage increase in about 30 years (though still only ~ +3.8% y/y).

  

  • This is the driving force for inflation in Japan to continue staying high without dropping much (green line), even though most major countries have reduced inflation. 

    

This year's Shunto wage negotiations started on 01/24 and are expected to conclude in the second half of March:

• Japanese Trade Union Confederation (also known as Rengo) - Japan's largest national trade union organization has set a target for superior wage increases +5% y/y – this is quite unrealistic.

• However, most G20 members believe that a wage growth above 4% is also enough to impress BoJ and the market.

  

The whole world is looking towards Shunto which will decide BoJ's April interest rates:

If BoJ really pivots and abandons negative interest rate policy, there will be 3 major impacts:

1. Japan will transform and return to economic growth:

• Even if Japan has another mild technical recession (as many times in the past) causing Japan to lose its position as the world's 3rd largest economy to Germany this time.

  

• …. this issue is not too serious:

  • Japan's economic recession this time mainly comes from the collapse in JPY value due to the US and EU keeping interest rates too high while BOJ still maintains negative rates.

  => Therefore, if BOJ abandons negative interest rate policy, Japan's economy can grow again!

2. On the Japanese financial market: Japanese stocks will revive.

• Currently, Japanese stocks have surpassed the 1990s peak, and Japanese stocks still have room to grow.

  

• The growth room for Japanese stocks comes from many Japanese companies being undervalued by the market compared to their intrinsic value, … partly due to the previous deflationary economy.

  

• Additionally, Japan is returning to the AI and tech game as the country revives the semiconductor industry - the hot race among major powers today:

  • A series of chip foundries in Japan are attracting investment back as stocks rise:

    

  • Even though many Japanese companies have lost ranking on the chip technology industry map:

    

  • … Japan still holds a very important role in many links of the global semiconductor supply chain:

    

3. On the international financial market: the wave of repatriation by Japanese Investors will drain liquidity from the rest of the world

• If interest rates in Japan rise, the wave of capital repatriation by Japanese investors will leave a hard-to-fill hole in the global financial system.

  • Because Japanese investors are still the world's largest creditors:

    

  • And they have full motivation to withdraw capital from international markets if interest rates in their domestic market rise high even though (still lower than interest rates in other markets:

    … simply because their cost of hedging exchange rate risk is increasingly rising if they continue to invest abroad.

    

CONCLUSION

A few points mentioned above are personal predictions of the Viet Hustler editorial team, for reference only and not investment advice at all. 

But with the context of the Japanese stock market revival, there is a very high possibility that the Japan Trade Union Confederation will successfully negotiate a large wage increase this year. And under pressure from the technical recession of the economy and momentum from the results of Shunto (if any), BOJ may abandon the negative interest rate policy from April/2024. At that time, the Japanese and global financial markets may gradually undergo a major correction as analyzed above.

For China, Viet Hustler believes that the 5% economic growth target that the market expects Li Qiang to propose at the Two Sessions is a quite challenging goal. Because if China cannot avoid this Liquidity Trap, not only in 2024 but also in many subsequent years, deflation will push China's economy into long-term stagnation. Meanwhile, the market is still awaiting China's new policies and how the country will use the proceeds of over CNY 1,000 billion in bonds just issued to stimulate the economy.

Finally, the Fed's interest rate policy decision at the March FOMC is quite predictable, but the Fed's attitude towards the interest rate cutting process is not as predictable. The March FOMC is precisely when Fed members meet to unify views on interest rates as well as macroeconomic targets for 2024. Therefore, the March FOMC is also a major event in the current phase of the US economy.