Rabo: Both The US And China Want A Reflationary Weaker Currency AND Lower Commodity Prices

By Michael Every of Rabobank

Three Babies and ‘The Man’

Yesterday saw the Chinese Politburo –‘The Man’, as they used to call state authority in the US– deciding it is now okay for Chinese families to have three babies, not two. So it was a case of “Three Babies and ‘The Man’”. However, this hardly made the media splash the shift from one to two children did in 2015 – and understandably so. This latest step underlines the message in the PBOC’s recent working paper on an ageing population, which called for radical action to see more births (and more mercantilism if the population declines). Yet the outcomes of this policy are, in most expert eyes, likely to be negligible. Why should families who didn’t rush to have two children when allowed now race to have three? As such, China’s rapid ageing and population decline will almost certainly continue, with major global implications – though as we noted in ‘A Midwife Crisis’, should it succeed in raising the number of babies to three, it would also have a huge impact given the size of its population and their commodity appetite.

China also made another splash, on the FX front, by raising the FX reserve requirement ratio by 2ppts to 7% for the first time since 2007, effectively locking up billions of FX in banks – not that it moved markets much in the end. This is the latest step in efforts to prevent CNY from appreciating against USD despite the huge trade surpluses China is running, and the large capital flows it is seeing from Western fund managers searching for yield. It is also about as clear a signal as those self-same Western fund managers can ever hope to be sent: some form of FX ‘action’ will continue, if not FX war – where China points to the US as the instigator. But there is a wrinkle.

Countries usually push back against FX appreciation because it is deflationary, and encourage depreciation because it is inflationary. Yet the US doesn’t like that a weaker USD also means higher commodity prices, partly because of Chinese demand: they want the juice of a stimulus-driven weaker USD with none of the pith and pips of inflation. For its part, China doesn’t like a stronger CNY partly because it encourages commodity inflation by making the price of these USD-priced imports cheaper in CNY terms, which allows demand to stay high even as USD prices rise. So both sides can perhaps agree short term that a signal of weaker CNY helps both fight inflation. However, in the bigger picture, both want a reflationary weaker currency (and China a “stable” one) and lower commodity prices – which can only happen if the other’s commodity demand drops significantly. How is FX cooperation going to work out then? “Success has many parents, but failure is an orphan” as they say.

Hedge funds are apparently getting the message near-term, however, as Bloomberg reports that they are scaling back bullish bets on commodities for a third week. Apparently this shift is for a variety of fundamental-based reasons, and “any future price gains will depend more on actual supply and demand rather than speculative buying across raw materials”. Sure they will – right up until global commodity prices start going up sharply again on the back of ultra-loose monetary policy and/or mega fiscal stimulus, or some kind of fresh geopolitical or logistical issue. Because that’s how markets, and hedge funds, work.

Underlining exactly these kind of risks, a cyber-attack has shut down an Australian plant of Brazillian-owned global meat-processing giant JBS, the world’s largest facility. The firm does not know if it will be out of action for days, or weeks, or multiple weeks, but the longer the closure lasts, the greater the market disruption. Fortunately, meat shortages do not look likely. However, just weeks after the US oil pipeline hack that saw gas stations empty and pump prices surge, the threat of ‘grey zone’ cyber warfare to Western economies has been made clear again. This attack was notably preceded by PMs Morrison and Ardern holding a joint press conference, where they agreed to support each other, Morrison adding “As great partners, friends, allies and deep family, there will be those far from here who would who would seek to divide us. They will not succeed.“

On which note, the EU still has no idea what to do about Belarus given it desires rapprochement with Russia and its Nord Stream 2 gas. Moreover, the Irish foreign minister just visited Beijing, and promised to “deepen cooperation” on cybersecurity, which may raise a few eyebrows in the US, to be “welcoming and open” to Chinese FDI, and stressed that signing the CAI investment deal was a priority – which may raise a few eyebrows in the EU parliament. While resonating well in Berlin, this is also more than a tad out of line with public opinion in Ireland; and it suggests another area of EU disunity within its “open strategic autonomy”, where the emphasis actually seems most to mostly be on the “open”.    

US President Biden meanwhile gave a Memorial Day speech at Arlington National Cemetery, in which he noted that democracy was worth dying for, yet that “Democracy itself is in peril, here at home and around the world. What we do now…how we honour the memory of the fallen, will determine whether or not democracy will long endure.” He added that we all take democracy “for granted”, and that “the biggest question” is whether it can win in a “struggle taking place around the world” against “autocracy.” That’s a very Cold War speech – but this isn’t reflected in most global markets headlines: logically one of the two must be wrong.

Lastly, the WHO is changing the name of different Covid-19 variants from numeric codes such as B.1.351 to a simple “Beta”, “Gama”, “Delta”, etc., to: 1) make things easier for the public; and 2) make things less stigmatizing for the countries where mutations arise – because stigma is obviously the largest public global health threat right now, and we don’t seem to have a vaccine against it. Meanwhile, the official US intelligence search goes on for the “Alpha” of Covid-19, and the knock-on “Omega” of the conclusion is far from clear.