Riding The Dragon

Here are some of the biggest stories from last week:

• The OECD is slightly more optimistic about global inflation and economic growth.
• Consumer prices in China fell at the fastest rate in 15 years in January.
• Chinese stocks surged after the government intensified its efforts to prop up the market.
• Central bank buying helped send gold demand to a record high last year.
• The world’s biggest digital currency surged above $47,000, reaching a one-month high.

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

Macro

In its latest economic outlook, the OECD said that the world's major central banks should stay on course in their efforts to combat inflation, as it is still uncertain whether aggressive interest rate hikes have successfully curbed underlying price pressures. It expects the Fed to begin cutting rates by the second quarter and for the BoE and ECB to follow in the third quarter. However, it warned that central banks should lower borrowing costs only gradually, and that monetary policy should remain restrictive for some time to come, suggesting policymakers should not slash rates back to the near-zero levels of before the pandemic.

The alarm comes despite the OECD slightly lowering its inflation forecasts for most major economies over the next two years. But it’s also understandable why the organization is cautious: it warned that factors helping bring inflation down, including improvements in supply chains and commodity costs, are dissipating or even reversing. What’s more, it sees the potential of a wider conflict in the Middle East that disrupts energy supplies as a big and growing economic risk. In fact, its most recent assessment found that the recent doubling in shipping costs stemming from Red Sea disruptions could add 0.4 percentage points to inflation after a year.

Finally, the OECD is slightly more optimistic about the global economy than before, although its improved 2024 forecast of a 2.9% expansion in global output still marks a slowdown from 3.1% last year. It only expects a slight up-tick to 3% in 2025. Within major economies, the US was particularly strong at the end of 2023, buoyed by robust consumer spending and labor market, prompting the OECD to revise up its forecast for 2024 growth to 2.1% from 1.5%. But that strength is largely offset by poorer expectations for most European nations, where the OECD said tight credit conditions are holding back activity. As a result, it cut its eurozone 2024 growth forecast to 0.6% from 0.9%.

Over in China, new data this week showed the world’s second-biggest economy remained stuck in deflation territory for a fourth straight month. Consumer prices fell by 0.8% in January from a year ago – steeper than the 0.5% forecast by economists and marking the biggest drop in almost 15 years. Adding insult to injury, producer prices, which reflect what factories charge wholesalers for products, fell for a 16th straight month, dropping by 2.5% in January.

Prolonged deflation – a result of weak domestic demand, an ongoing property crisis, a sluggish job market, and falling exports – is a big risk for China because it can lead to a downward spiral of economic activity. Anticipating further price drops, consumers might delay purchases, further dampening already weak consumption. Businesses, in turn, might lower production and investment due to the uncertain demand outlook.

Stocks

The Chinese government stepped up its efforts to stem a market rout that has sent the CSI 300 index tumbling more than 40% from its February 2021 peak to a five-year low. Shares began climbing on Tuesday after Central Huijin, an investment arm of China’s sovereign wealth fund, said it would expand its purchases of local ETFs. That was soon followed by another announcement by the China Securities Regulatory Commission, which said that it would encourage institutional investors to hold A-shares for a longer period of time. The announcements sent the CSI 300 and Hang Seng indexes 3.5% and 4% higher on Tuesday, respectively.

The latest initiative follows recent efforts by authorities to bolster the country's faltering stock market, including limits on short-selling, cuts to trading fees, and purchases of bank shares by a government investment fund. But those measures have so far failed to restore investor confidence, which has been hurt in recent years by an economic slowdown, regulatory actions targeting corporations, an ongoing debt crisis in the property sector, and escalating geopolitical tensions with the West.

Commodities

The World Gold Council’s latest figures out this month showed total global demand for the shiny metal increased by 3% last year to hit a record 4,899 tons. That includes central bank buying, jewelry demand, investment flows, industrial consumption, and over-the-counter purchases – an opaque source of buying by wealthy individuals, sovereign wealth funds, and futures market speculators.

The record demand levels helped send the price of gold 13% higher last year, touching a record in December. That surge came despite significantly higher bond yields, which increased the “opportunity cost” of owning gold since it doesn’t generate any income. In fact, the increased attractiveness of bonds relative to the non-yielding metal helped push investment demand for gold to a ten-year low of 945 tons.

But offsetting that weakness was blistering central bank buying and strong jewelry demand in China. Central banks kept on snapping up the precious metal at breakneck pace last year, with total net buying of 1,037 tons – just 45 tons shy of the record set in 2022. This surge in purchases over the past two years is part of efforts by countries to hedge against inflation and diversify their reserves to reduce their exposure to the US dollar. Making the biggest move is China’s central bank, which bought 225 tons of gold last year.

Chinese consumers have also taken a shine to gold, hoovering it up as a potentially safe store of wealth in the face of a property crisis, a falling yuan, tumbling yields, and a slumping stock market. Chinese investment demand for gold increased by 28% last year to 280 tons, while jewelry consumption increased by 10% to 630 tons.

Looking ahead, the World Gold Council expects total global demand for the shiny metal to expand again in 2024 amid heightened geopolitical tensions and the Fed’s imminent interest rate cuts. Investors typically like to own gold in a rate-cutting cycle as it benefits from lower bond yields and a weaker dollar. What’s more, amid rising geopolitical tensions, gold could also see increased demand due to its reputation as a safe-haven asset.

Crypto

Bitcoin surged above $47,000 on Friday, marking its highest level since the inception of the first US ETFs investing directly in the cryptocurrency. This breakout is attributed to bitcoin's historically strong performance during the Chinese New Year and signs of steady inflows into the spot ETFs, which have attracted a net $8 billion so far. The OG-crypto is also benefiting from growing attention on the so-called “halving" due in April. The event occurs approximately every four years, reducing the reward for mining new bitcoin blocks by half. This process is a part of bitcoin's monetary policy, designed to control supply inflation by decreasing the rate at which new bitcoins are created. Previous halving events typically preceded strong bull runs, so you can understand why traders are getting excited.

Next week

• Monday: US federal budget (January).
• Tuesday: UK labor market report (January), US inflation (January). Earnings: Coca-Cola, Airbnb, Shopify.
• Wednesday: UK inflation (January), China foreign direct investment (January). Earnings: Kraft Heinz, Cisco, Occidental Petroleum.
• Thursday: Japan GDP (Q4), UK GDP (Q4), eurozone trade balance (December), US retail sales and industrial production (January). Earnings: Coinbase, Deere, Applied Materials.
• Friday: UK retail sales (January), US housing starts (January), US consumer sentiment (February).