How China’s economic pain will help US Fed rate cuts

China, Asia’s largest economy, is having a rough patch.

It’s too soon to lose faith in the big idea that’s driven markets since December: Inflation is wounded, perhaps mortally, and the next move in interest rates will be down. If you are wavering, take a break from reading the entrails of US consumer prices, ruminating over whether hawks have the upper hand in Europe, or replaying the Reserve Bank of Australia chief's first press conference. You need to look at what’s transpiring in China.

Asia’s largest economy, not long ago considered a contender to supplant the US, is having a rough patch. Growth has struggled after the pandemic,foreign investment is waning, and real estate companies are failing. But the most pernicious development has been deflation. When consumer prices posted a small decline in July, the figure was seen as a blip. It hasn't really let up and January showed the biggest drop since 2009.

The risk is that traders are so focused on Federal Reserve Chair Jerome Powell that they dismiss what Pan Gongsheng, his counterpart in Beijing, is contending with. That would be a mistake. The longer China refrains from meaningful efforts to arrest deflation, the greater the risk it becomes entrenched — and all the tougher to escape. Citigroup Inc. economists were prescient when they warned in May of a “confidence trap.”    

The opening of China’s economy, its entrance into the global labor pool and the World Trade Organization are widely considered to be seminal events.
They were critical to the low-inflation regime that prevailed pretty much everywhere in the decades prior to Covid. China may once again prove pivotal — this time in eclipse. It will help drive inflation down from levels authorities around the world remain less than enthusiastic about, despite a pronounced retreat since mid-2022.

Arguably, the battle is won. Officials just don’t want you to think so. The small chance they could be wrong is enough to persuade them to wait. June appears to be a more likely proposition for the Fed to kick off a global cycle than March, which policymakers never gave any serious indication they favoured, but that became an early pick among investors.

At times, central banks seem to be even looking for excuses not to cut: A couple of Fed presidents suggested recently they want to see broader declines in inflation, not just a continuation of a slowdown. The Reserve Bank of Australia is cautious to a fault: “The board hasn’t ruled out a further increase in interest rates but neither has it ruled it in,” Governor Michele Bullock told lawmakers. If officials are grasping for new reasons to refrain from easing, they won’t find them in China.

Powell told 60 minutes that China’s difficulties are unlikely to have much of an impact on the US. He’s right that slackening demand or the failure of property developers there won’t cause American growth to suddenly end or send the financial system into a tailspin the way Russia’s default in 1998 imperiled Wall Street. Deflation may be a slow burn, something more subtle. That doesn’t mean it will be without consequence.

The end of China’s property boom will have serious implications for commodity prices. “Since its 2001 accession to the WTO, China has steadily exerted downward pressure on global manufactured goods prices, while simultaneously being a massive inflationary force for the commodity inputs that fueled its buildout of property and industrial capacity,” Thomas Gatley, senior analyst at Gavekal Dragonomics, wrote last week. “With its historic housing boom clearly over, the government is putting all its chips on an expansion of manufacturing to drive future growth.”

Powell may have been too dismissive of China’s travails. With the American economy defying predictions of recession, he can afford to be. The one thing he doesn’t want to appear to be is too sympathetic, or worse still, set US policy on the basis of challenging times in its economic rival.  

The once unstoppable juggernaut now has problems that don’t look transitory. That’s painful for China, but not all bad for everyone else.

Daniel Moss is a Bloomberg Opinion columnist. Views do not represent the stand of this publication. 

Credit: Bloomberg