We\u2019re seeing signs that China\u2019s reopening is having a substantial positive impact on the economy, especially the services sector. <\/p>\n\n\n\n
I expect Federal Reserve Chair Jay Powell to pledge to remain tough on inflation, but also to stay data dependent.<\/p>\n\n\n\n
I\u2019m hopeful February\u2019s report will be similar to January\u2019s report, in which job increases exceeded expectations more than wage growth did. <\/p>\n\n\n\n
It\u2019s been more than three months since China loosened its zero-COVID protocols and reopened its economy. Many were skeptical about the benefit to China\u2019s economy, with concerns that this could unleash an enormous wave of COVID infections. However, I was an early China bull. I was encouraged by the high percentage of fully vaccinated in China\u2019s population \u2013 far higher than other countries that had successfully reopened. What\u2019s more, I thought the reopening could be a powerful juggernaut for the economy.<\/p>\n\n\n\n
Why? I saw how demand increased quickly after Western developed countries reopened following the pandemic. And given that China\u2019s zero-COVID policy lasted far longer than these countries\u2019 stringent conditions, I assumed there would be a much higher level of pent-up demand, which could provide a large boost the services sector. Today, we\u2019re starting to see the evidence.<\/p>\n\n\n\n
We\u2019re seeing signs that the reopening is having a substantial positive impact on the Chinese economy, especially the services sector. For example, the Caixin\/S&P Global Services Purchasing Managers’ Index (PMI) rose from 52.9 in January to 55.0 in February.1<\/a><\/sup> And the official NBS Non-Manufacturing PMI for China rose from 54.4 in January to 56.3 in February, its highest level since March 2021.2<\/a><\/sup> My key takeaway: the \u201crevenge living\u201d I had anticipated has begun. (It\u2019s also worth noting that manufacturing activity has improved as well.)<\/p>\n\n\n\n Not surprisingly, China bulls have multiplied since the reopening announcement last fall. But that sentiment has been called into question by the National People\u2019s Congress, which started last weekend with the delivery of the Government Work Report (GWR) by Premier Li Keqiang. Investors are disappointed by the \u201caround 5%\u201d target set for gross domestic product (GDP) growth this year by Chinese policymakers, as many had hoped for a target of 5.5% or even 6%.<\/p>\n\n\n\n Some are assuming the worst \u2013 that China set a low target because regulation is going to increase significantly this year. Others believe the message being sent is that China will not provide significant stimulus to its economy. However, I don\u2019t believe either is the case. Policymakers have said they would support the platform economy and have also pledged to protect the rights of private businesses and entrepreneurs. In addition, policymakers pledged more effective and significant accommodative fiscal policy. And so I have a simpler perspective on the growth target: After a challenging 2022, policymakers may just be more comfortable setting the bar low so that it\u2019s easier to handily beat it.<\/p>\n\n\n\n This is a big week for the Fed. It started several days ago with the release of its Monetary Policy Report, which is a precursor to Fed Chair Jay Powell\u2019s semi-annual Humphrey-Hawkins testimony to Congress on March 7. And the US February jobs report will be released on March 10. This comes on the heels of some rather hawkish rhetoric from various Fed officials.<\/p>\n\n\n\n I view these comments as part of the Fed\u2019s campaign to talk down markets and stop them from getting ahead of themselves by prematurely loosening financial conditions. I\u2019m not spooked by these quotes \u2013 in fact, I\u2019d be spooked if they weren\u2019t<\/em> trying to talk down markets, as this should be part of the tools in their toolbox.<\/p>\n\n\n\n Let\u2019s spend a little time on the Monetary Policy Report, which reiterated what we\u2019ve heard time and again from the Fed: inflation is too high and the economy will need to slow. However, that should come as no surprise as the report is always largely backward-looking. I\u2019m more interested in the \u201cspecial topics\u201d that give me a sense of what is on the Fed\u2019s mind.<\/p>\n\n\n\n For example, the Fed tackled labor market conditions, looking at what caused low labor force participation and anticipating that conditions are likely to remain challenging going forward. The report also covered developments in the Fed\u2019s balance sheet and the impact on markets. The Fed noted that market liquidity is low in areas such as the Treasury market. The Fed recognized that it may need to alter its Quantitative Tightening strategy to manage market functioning and liquidity (this is likely to be a meaty topic during Powell\u2019s Congressional testimony as well). Interestingly, the report also noted that high interest rates have caused the Fed\u2019s interest expenses to increase significantly, which in turn has resulted in negative net income.<\/p>\n\n\n\n My biggest takeaway from the Monetary Policy Report has to do with its coverage of inflation expectations, which it deems to be well-anchored. It detailed examples of longer-term consumer and market-based inflation expectations remaining \u201cbroadly consistent with the FOMC\u2019s (Federal Open Market Committee) longer-run 2% inflation objective,\u201d and even mentioned that shorter-term inflation expectations are lower than where they were in mid-2022.6<\/a><\/sup><\/p>\n\n\n\n With regard to Powell\u2019s Humphrey-Hawkins testimony, there is of course significant speculation about what he will say regarding how comfortable the Fed is with the current inflation picture and what its plans are for monetary policy. I think Powell will largely echo the hawkish rhetoric from Daly and Bostic, underscoring the problems caused by inflation and pledging to remain tough \u2013 especially maintaining the terminal rate for some time. However, I think Powell will also stress that the Fed will ultimately be data dependent.<\/p>\n\n\n\n So what could that mean? We need to read between the lines \u2013 statements like that don\u2019t mean the Fed has to hike rates to 6% or higher. I continue to believe the Fed is likely to give us two more 25 basis point hikes and then enact a \u201cconditional pause\u201d while continuing to talk tough. I believe the Fed will lean on tame inflation expectations as a reason to pause sooner rather than later. Recall that the Fed is a big believer in the importance of inflation expectations in determining future inflation, so I believe its positive assessment of current expectations will likely cause it to err on the side of fewer rate hikes. I do believe there will be no rate cuts this year \u2013 unless the US economy deteriorates far more than I expect \u2013 but that is appropriate given the current strength of the US economy.<\/p>\n\n\n\n Finally, the US jobs report will be released on Friday. I suspect job growth will be rather plentiful, but I\u2019m hopeful it will be similar to January\u2019s report, in which job increases exceeded expectations more than wage growth did. Of course, key data points to focus on will be labor force participation and especially average hourly earnings, given the impact on inflation.<\/p>\n\n\n\n This should be an interesting, eventful week. But I don\u2019t want to get too myopic. Investors are in a marathon, not a sprint, so we need to take a step back and look at the bigger picture. That means we should expect volatility in the next several months given monetary policy uncertainty \u2013 and a looming debt ceiling crisis<\/a> in the US. It also means we need to take another step back and look at the even bigger picture \u2013 being well diversified across and within major asset classes for years to come, ignoring the background noise, and focusing on our long-term goals.<\/p>\n\n\n\n Footnotes<\/strong><\/p>\n\n\n\nA big week for the Federal Reserve<\/strong><\/h2>\n\n\n\n
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Fed report shows inflation is too high<\/strong><\/h2>\n\n\n\n
What will Powell tell Congress?<\/strong><\/h2>\n\n\n\n
Watching the US jobs report<\/strong><\/h2>\n\n\n\n
Looking at the bigger picture<\/strong><\/h2>\n\n\n\n