China's #1 Ambitions Are Fading

Here are some of the biggest stories from last week:

• Economists' forecasts for global growth this year and next are diverging.
• China’s trade slump eased in August, with exports and imports falling by less than expected.
• China's prospects of overtaking the US as the world's biggest economy are diminishing.
• The Fed hit a key milestone with its quantitative tightening program.
• The price of Brent oil soared after Saudi Arabia and Russia extended their voluntary supply curbs until the end of the year.

Dig deeper into these stories in this week’s review.

Macro

Economists' forecasts for global growth in 2023 and 2024 have diverged significantly over the course of the year. They’ve raised their estimates for this year's performance by nearly 1 percentage point since January, as stronger-than-expected consumer demand and resilient labor markets have shielded the global economy from a major slowdown. In contrast, they’ve been slashing their 2024 forecasts, with growth now expected to come in at 2.1%, according to a compiled analysis by consultancy Consensus Economics, down from this year's 2.4%.

There are a few reasons for that pessimism. First, this year’s better-than-expected economic performance flattens growth in 2024 due to the base effect (when a high growth rate in one period impacts the comparative growth rate in the next). Second, strong consumer demand and wage growth are expected to keep inflation higher for longer, forcing central banks in advanced economies to keep interest rates elevated well into next year. Those high interest rates are, in turn, expected to drag down economic growth. Third, China’s disappointing post-pandemic recovery is weighing on the global economy. After all, China was meant to be the top contributor to global growth over the next five years, with a share expected to represent 22.6% of the total, according to the International Monetary Fund.

So while investors had entered 2023 bracing themselves for a significant economic slowdown, the global economy has proved to be quite resilient. That’s prompted economists to revise their initially gloomy forecasts for the year, pushing their expectations of a slowdown to 2024 instead. But it also shows that investors should take economic forecasts with a grain of salt, as they are subject to change based on many unpredictable factors.

Speaking of China, the world’s second-biggest economy finally got some good (albeit small) news last week, with the country’s trade slump easing in August. In dollar terms, Chinese exports fell 8.8% from a year earlier while imports contracted 7.3% – both better than estimates and significantly less severe than July’s downturn of 14.5% and 12.4% respectively.

China's exports played a significant role in supporting its economy during three years of global restrictions, but they’ve declined (on a year-on-year basis) in each of the past four months due to high global inflation and rising interest rates that have dampened demand for the country’s products. Falling imports, meanwhile, highlight the disappointing state of domestic demand nine months after China abandoned its strict zero-Covid policies.

But August’s milder decline in imports could be a sign that the downturn in domestic demand may be bottoming out. In recent weeks, China's government has rolled out a series of measures to boost business confidence and support the struggling property market. The latter has been a significant source of stress on the economy, with Goldman Sachs estimating that the housing downturn will reduce China’s GDP growth by 1.5 percentage points this year.

That real estate slump, combined with falling exports and fading confidence in the government’s management of the economy, has led China to down-shift to a slower growth path sooner than many economists had anticipated. The country is also contending with deeper, longer-term challenges, with the nation’s population shrinking in 2022 for the first time in six decades. Taken altogether, China is no longer set to overtake the US as the world’s biggest economy in the near future. That’s according to a new analysis by Bloomberg Economics, which forecasts that it will now take until the mid-2040s for China’s GDP to exceed the US’s. Even then, the lead will be marginal and short-lived. Before the pandemic, China was expected to take and hold the number one position as early as the start of the next decade.

Bonds

As part of its most restrictive monetary measures in years, the US central bank is allowing up to $60 billion in Treasuries and $35 billion in mortgage-backed securities to mature every month without reinvestment. Those measures, called “quantitative tightening”, hit a key milestone last week: the Fed has now offloaded $1 trillion in bond holdings since it began shrinking its bloated balance sheet last year. And the good news is that, so far, the Fed has managed to accomplish this feat without triggering any of the kind of strains in financial markets that spooked policymakers the last time they oversaw such a program. The central bank’s balance sheet now sits at about $7.4 trillion – down from the record $8.4 trillion reached in April last year, according to new data out last week.

The bad news is that with the Fed stepping away as a major buyer of bonds, the Treasury Department has to rely more heavily on the private sector to snap up federal debt. That comes at a time when the US government’s budget deficit is ballooning on the back of tax cuts, stimulus measures, higher defense costs, increased spending on government programs, and growing debt-servicing costs. To plug that gap, the US Treasury Department is forced to sell more and more bonds. For example, it recently boosted its net borrowing estimate for the current quarter to $1 trillion – a serious leap from the $733 billion it predicted in early May.

Commodities

The price of Brent oil soared above $90 a barrel for the first time in 2023 last week after Saudi Arabia and Russia said they would extend their voluntary supply curbs until the end of the year. Saudi Arabia, the de facto leader of the OPEC+ cartel, has removed 1 million barrels a day from the global market since July in what was initially meant to be a temporary measure. But having already extended the cut until the end of September, the kingdom announced last Tuesday that it’s keeping the reduction in place until the end of December. That means Saudi Arabia’s output is likely to remain at 9 million barrels a day through the end of the year, 25% below its maximum production capacity. Similarly, Russia has voluntarily reduced its exports by 300,000 barrels a day, and announced last Tuesday that it’s extending the cut until year's end.

This week

• Monday: Earnings: Oracle.
• Tuesday: UK labor market report (August).
• Wednesday: US inflation (August), UK GDP (July), eurozone industrial production (July).
• Thursday: European Central Bank interest rate announcement, US retail sales (August). Earnings: Adobe.
• Friday: China retail sales and industrial production (August), US industrial production (August).