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There were two key events for markets at the end of July: the dramatic fall of certain Chinese shares, and the meeting of the US Federal Open Market Committee.
In principle, there is no connection between these two events. In reality, they have one thing in common: a political preoccupation with improved social and national cohesion at the expense of strict economic orthodoxy.
In China, the fall in markets is partly due to political intervention aimed at reining in the profits of companies offering tuition in parallel to the education system. The high price of such tuition is a handicap for the middle classes, even if it may enable the country to boost its educational performance. Xi Jinping decided that it would be preferable, politically, to avoid further widening inequalities, even if it means reducing the performance of one part of the population. In addition, it is better to restrict the cost of education in a country with a low birth rate, even if it means foregoing the economic benefit from companies in the education sector that could have contributed to China’s global influence. And if the education sector has been reined in, surely there is a risk for other sectors too in the future. This could be the case for healthcare in particular, which is very expensive and discriminatory, despite the promises made by a communist society. Stocks in this sector of course declined in concert, as they implicitly face the threat of the same kind of restrictions.
An additional reason for the fall in the Chinese market was the suggestion that the opportunities for Chinese companies to list in the US via American Depositary Receipts (ADR) may be reduced. On this issue, the political desire for freedom from US accounting requirements is set against the ambition for broader access to the foreign capital flows that are essential to China’s growth. National independence is hard to reconcile with the adoption of international, i.e. US, standards. The economic war between the US and China is also a war of standards, entailing a degree of collateral damage, namely access to US capital.
So what does this have to do with the Fed meeting of 28 July? In principle, nothing. Except that its Chair acknowledged that the high level of inflation in the US (4.5% for the least volatile element in June) could prove less transitory than forecast, thus warranting a much less accommodative monetary policy than is the case currently. However, Jerome Powell also intimated that the target of reducing unemployment among society’s least privileged groups currently takes priority over all other considerations, and justifies a very expansionary monetary policy. So here too, social cohesion is being given precedence over economic orthodoxy in its strictest sense. This is even more urgent, since the Fed is accused of having dramatically widened wealth inequalities by inflating the price of risky assets, i.e. the assets of the most privileged, thus paving the way for populist movements.
Whether we consider this a good or a bad thing, the influence of liberal economic principles is clearly on the wane currently. In China, the capitalist economy and socialist policies are meeting in a middle ground, which is hardly a shock amidst celebrations of the centenary of the Chinese communist party. But it is surprising, given that the country is dependent on the private sector and needs to attract foreign capital in order to increase its power. And it is even more surprising in the country that is the flag bearer of capitalism. But even in the US, crises have illustrated the extent to which liberal principles are forgotten in an emergency. On this issue, “Xi Powell” and “Jerome Jinping” are in harmony, like yin and yang.
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TELEX
Inflation is falling again in the eurozone. “Core” inflation (excluding volatile elements) in the eurozone returned to close to its 5-year average of 0.7% year-on-year in July, versus 0.9% in June (and a peak of 1.4% in January). However, 5-year, 5-year forward inflation expectations have risen in recent weeks to 1.7%, indicating that investors are buying into the assumption that inflation will rise moderately from its particularly low level currently.
The rise in US inflation is easing. Core personal consumption expenditure (PCE), closely watched by a market focussed on the return of inflation as a key issue, rose 3.5% in June, versus expectations of a 3.7% rise. Coming in slightly below expectations, this figure may provide support for the assumption that medium-term inflation will remain under control. Furthermore, 5-year, 5-year forward inflation expectations remain close to 2.4% in the US. The market does not currently expect any overheating. However, we should bear in mind that the moratorium on evictions for non-payment of rents is due to end imminently, which could result in a sharp rise in the real-estate component of inflation in the near future.
By Olivier de Berranger, CIO, LFDE