News of the week summary - 05/14/2023

Chinese imports drop amid lackluster economic recovery.

China's economic outlook is raising concerns as its imports unexpectedly fell by almost 8%, marking the most significant drop since January. In contrast, exports saw an increase of 8.5% compared to the previous year but slowed down from the double-digit growth observed in March. China's recovery has been driven by consumer spending rather than infrastructure and property investment, reducing the demand for commodities like crude oil, iron ore, and copper, which, consequently, experienced a drop in imports in April.

The unexpected decline in imports could spell trouble for economies that anticipated China's economic recovery to boost their own export growth, notably for neighboring countries like Japan and South Korea. Global inflation, rising interest rates, and high inventory levels, along with the ongoing war in Ukraine, are anticipated to limit global consumer demand, potentially impacting further China's export growth.

Analysts are speculating whether Chinese authorities will introduce more supportive measures to stimulate the economy. Some see the possibility of a policy rate cut this quarter, while others anticipate government support to counter the deteriorating global economy's impact on the country’s manufacturing sector. Such support could involve bolstering the labor market in the industry through more electric vehicle subsidies or accelerating infrastructure projects.

Notably, Southeast Asian nations became China's largest trading partners in the first four months of the year, highlighting the shifting dynamics of global trade. Meanwhile, trade with the U.S. and the EU declined, while sectors like automobiles, refined oil, and steel products experienced substantial growth in China's exports during the same period.

 

US inflations slows, hinting at possible rate hikes pause.

In April, U.S. inflation exhibited signs of moderation, providing the Federal Reserve with room to potentially pause its interest rate increases. The consumer price index (CPI), which is a measure of the change in the prices paid by consumers for a sample basket of goods and services, rose by 4.9% from the previous year, falling below expectations and marking the first reading below 5% in two years! Even when excluding food and energy, inflation also experienced a slight cooling effect.

A narrower price measure, often emphasized by Fed officials, which tracks services that thrived as the pandemic receded, showed the smallest monthly increase since mid-2022. This was due to declining airfares and hotel costs.

Following this report, U.S. stock futures rose, Treasury bonds rallied, and the dollar weakened, as investors anticipate a pause in rates increase.

The FED’s report suggests that inflation is cooling due to rate increases and recent credit stress working their way through the economy. Nonetheless, overall prices continue to be far above the central bank’s 2% target, and the job market remains robust (which usually means high wages and thus high consumption, stimulating demand and therefore inflation). The Fed will need more than one month of data to be confident that price pressures are on a stable downward path.

 

German industrial production declines, raising fears of recession.

German industrial production experienced a significant decline of 3.4% in March, exceeding economists' expectations, raising concerns that Europe's largest economy may have slipped into a winter recession. This manufacturing downturn, particularly pronounced in the automotive sector, could lead to a downward revision of Germany's first-quarter GDP estimates. Germany is on the edge of recession following Russia's attack on Ukraine and rising inflation, with a preliminary estimate for the first quarter of the year indicating stagnation.

Retail sales and exports also witnessed substantial drops. The economic landscape reflects shifting consumer preferences, with services prioritized over goods consumption.

 

Cost of insuring US Treasuries rises substantially as the country approaches its current debt limit

The cost of insuring U.S. Treasuries against default has surged to levels surpassing some emerging markets and even junk-rated nations, adding to concerns about the impending day when the US government could run out of money. It is currently more expensive to insure US bonds than those of countries like Greece, Mexico, and Brazil, which have defaulted multiple times and have significantly lower credit ratings than the US.

While few investors doubt that America will completely default on its debt, even a technical default, which involves a delay in interest and principal payments, could disrupt the $24 trillion Treasury market, a pillar of the global financial system.

This situation creates opportunities for those holding credit-default swaps (insurances against default) on US Treasuries maturing in less than 1 year, without owning the underlying security. Indeed, in case of a default or payment delay they could sell the swaps for a higher price without bearing the loss on the underlying asset. Still, most investors believe that a last-hour deal will avert a technical default, as has occurred in the past.