Fed View: Unconvinced on inflation, and unfazed by market volatility – Following St Louis Fed president Bullard’s remarks yesterday, we had a host of Fed speakers on the wires today, while voting hawk Williams is due to speak later this evening. The most notable comments came from Dallas Fed President Kaplan, who was a voter last year but not in 2018-19. We regard Kaplan as a centrist on the FOMC, and his comments today had something for both the hawks and the doves. On the dovish side, Kaplan – like Bullard yesterday – expressed his doubts about the prospects for inflation, stating that he is “less convinced [wage pressures] will necessarily translate into higher inflation” because technological advances mean businesses have less pricing power. We concur with this view, and believe the response of corporates to higher wages will likely be to take a hit on margins rather than risk losing market share in the near term (something we discuss in our US Watch: Why inflation might continue to disappoint – see link here). On the more hawkish side, Kaplan suggested the recent equity market correction would not necessarily get in the way of his support for further rate hikes, calling such corrections ‘healthy’. NY Fed President Dudley, a voting centrist this year, also said today that “this wasn’t that big of a bump in the stock market.” While their view is probably reflective of most on the FOMC, how the Fed responds will depend greatly on the magnitude of the correction; disorderly market moves would stay the Fed’s hand, in our view. All told, FOMC members look like they remain committed to a gradual pace of rate hikes, and we continue to expect core inflation to remain benign this year, even with accelerating wage growth. (Bill Diviney)180207-Global-Daily.pdf (45 KB)
China Macro: FX reserves rise for 12th consecutive month – China’s FX reserves – published this morning – rose by USD 21.5bn in January. Although the increase was slightly below consensus expectations, it was the largest increase in six months and the 12th monthly rise in a row. FX reserves have now recovered by a cumulative 5.5% since January 2017, after a 25% drop between mid-2014 and early 2017 added to China-related concerns. This recovery of FX reserves has been partly driven by an easing of capital outflows. According to Bloomberg estimates, capital outflows more or less halved in 2017 compared to 2015 and 2016. That does not only reflect tighter capital restrictions imposed in late 2016, but also firmer market expectations regarding the Chinese yuan. Partly responding to pressures from Washington, Beijing has tolerated an appreciation of the yuan versus the US dollar by almost 10% since end-2016. That development caused capital outflows that were related to expectations of CNY weakening versus USD (such as downpayments on USD exposure) to halt or even reverse it. Rising inflows, with sentiment versus EMs favourable last year and China being gradually included in global bond and equity markets, also played a role in supporting FX reserves. Looking ahead, the PBoC may now reverse some of the previous tightening of capital restrictions (although the Chinese central bank may want to see some easing of global market turmoil first). Still, we believe capital account liberalisation will remain a very gradual affair, as Beijing will continue to weigh the benefits of a more open capital account with macro-financial stability considerations (Arjen van Dijkhuizen).