Is it possible China is preparing for another lockdown at some critical level of Covid cases?

Outlook: We get PPI and consumer sentiment today, scheduled to cause a stir but just as likely to fizzle. As noted before, PPI has been declining nicely since April. It was 8.0% y/y last month from 8.4% the month before and expected down to 7.2% today. A 7.2% reading would be 4.5% under the March peak reading–pretty darn big. Notice that for most of the year, expectations have been too high and the resolution of many supply chain issues has resulted in lower-than-expected outcomes.  

Somewhat strangely, a “good” number like 7.2% or anything lower is bad news for the dollar, because it keeps awake that idea the Fed can do less and will start doing less sooner. A higher number would be a shock and give the dollar some support, if fleetingly.  

Ah, the difference between what they say and what they do–sentiment surveys like the University of Michigan's index do not capture reality. In November, the index ended up revised higher to 56.8 from the preliminary of 54.7. The subindex for expectations was revised higher to 55.6 from 52.7. And inflation expectations for the year ahead lost momentum at 4.9% from 5.1% in the flash while the 5-year outlook was unchanged at 3%.  

This time the market expects the sentiment index to come in only a skinch higher than Nov’s 56.8 at 56.9, despite the excellent holiday shopping we just saw. For what it’s worth, Trading Economics sees a dip to 56.4. But never mind–you can’t draw much conclusion from tiny changes like this. Anything in the high 50’s is good. We had a too-high 70.6 a year ago in Dec on wild happiness the pandemic was over, and then a too-low 50 in June when inflation started to bite–both outliers.  

Forecast: the dollar will continue softer unless there is sizeable geopolitical crisis that drives investors back to the safe-haven, or the US data is so unfavorable (inflation persistently high) that they remember “oh yeah, Powell said higher for longer.”  

For what it’s worth: We don’t believe the China story for a minute–the government relaxing Covid restrictions on protests and/or in part on pressure from Foxconn, which was losing business. Tiananmen Square might have been a long time ago (1989) but repression of the public doesn’t change. Locking down entire apartment buildings and forcing people into hospital camps was taking place only weeks ago. Something else is going on. Some suggest it’s a newfound prioritization of the economy. One contributing factor–the much-cited very high (20%) unemployment rate among young men. In the absence of guns, it’s hard to see why this would matter so much. Is it possible China is preparing for another lockdown at some critical level of Covid cases? Or preparing to invade Taiwan (or block the Strait)? Whatever is being prepared behind the curtain, it doesn’t justify stock market rallies.  

Tidbit: About that awful, terrible, really bad winter Britain is about to get that we wrote about yesterday–last night PBS replayed an old Nova documentary about Dunkirk. The key was Churchill refusing to agree with members of his cabinet who wanted peace talks with Germany. (An equally important key was disabling German mines by magnetizing ships.) The rescue itself was so emotionally moving that the public was able to see past what was really a massive military failure. Does the UK now need leadership of this caliber and does Sunak have it? In any case, we shouldn’t underestimate the people’s ability to pull off another Dunkirk. Tough birds, those Brits (whatever Liz said).  

Tidbit 2: See the chart. If the US oil inventory is at a 36-year low, doesn’t that imply upward pressure on oil prices? Well, no, not if output keep running at a hot rate. Still, this can’t be good. The US will start buying around $70 for the Strategic Oil Reserves and West Texas Intermediate hit $71.46 yesterday. The news the US is buying will be a rumor-mill story for some time.

Meanwhile, an interesting side story–after the Keystone pipeline was shut down due to a leak in the US Midwest (one report has Nebraska and another has Kansas), WTI prices jumped about $3–but fell back the same day to the new low near $71. This suggests the market is convinced of lower oil prices pretty much no matter what.  

Tidbit 3: The BIS issued an alarming report on the unknown size and nature of FX currency swaps. A number of articles raise the alarm, including the FT, which says the off-balance sheet nature of forwards and swaps is a black hole (for regulators).   

“And that hole is astonishingly big. The BIS detective work suggests that there are “$80tn-plus” in outstanding obligations to pay US dollars in FX swaps – or forwards – and currency swaps. This has doubled in the past decade, with a $5tn churn each day. Some $39tn of this involve non-American banks, and another $26tn non-American, non-bank entities such as hedge funds and insurance companies. Moreover, the non-bank category has grown rapidly, dwarfing on-balance sheet risks, and is often associated with maturity mismatches.  

“Thankfully, there is no sign of current stress. But history shows that FX swaps markets are “vulnerable to funding squeezes”, the BIS notes. This is because when shocks hit, investors worry about how to repay these dollar obligations, creating wild price gyrations.” The author skates over the main remedy–the US Treasury and Fed, which simply create money to lend it to the central banks whose domestic banks get into trouble. This is not a manufactured problem–it’s real, especially that non-bank participation. But it’s not an imminent threat, either.

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