The eyes of global investors are on the Fed – and US inflation. To understand how the latter will evolve, they should pay more attention to the world’s second largest economy.
China’s influence on the US inflation picture will be more profound than many realize, but also works through two different channels. Which ends up dominating will be a major factor in inflation later in the year, and how aggressively the Fed will eventually have to move to curb it.
The first channel is additional gravel in the global supply chain. Strict measures to contain the Omicron variant in the world’s largest manufacturer have threw a wrench into global production and logistics networks. Many cities, including Shanghai, have been closed for weeks. Factories have been closed and ports overcrowded. China’s industrial production fell by 2.9% year-on-year in April, while export growth measured in dollars slowed to 3.9% – the slowest pace in almost two years.
Things can be improved in the short term, as Shanghai – a major port and business center – plans to gradually reopen, but China’s zero-tolerance approach to Covid-19 does not appear to be disappearing. There may be on-and-off lockdowns across the country and disruptions to business activity for quite some time, potentially pushing up the prices of manufactured goods globally during this year and into 2023.
Slower exports from China and easing congestion of ports on the US west coast have recently meant lower freight rates. But the backlog of containers in the port of Shanghai, as Chinese exports rise to compensate for the lost time, is also likely to spread to the west coast during the summer months, according to Fitch Ratings.
One saving is that as the U.S. economy continues to open up, consumption has shifted back to services from goods, which may help reduce the strain on Chinese and global manufacturing and logistics networks.
To make matters even more complicated, however, China’s zero-Covid policy also has a separate, dampening effect on global inflation: Slower growth in the world’s largest consumer of most important industrial commodities puts a lid on rising material prices. Industrial metal prices such as iron ore and copper have fallen in the last month or so – especially since China’s housing market remains sluggish on top of the headwind from Omicron.
Perhaps most importantly from the perspective of the United States, Chinese shutdowns and slower industrial activity also mean lower demand from the world’s largest oil importer. Despite a recovery in April, China’s crude oil imports have fallen 4.9% year-on-year to 2021. The US Energy Information Administration and International Energy Agency both mentioned a softer consumption in China as they downgraded their 2022 oil demand forecasts. In this month.
For U.S. consumers, who are squeezed by both high gasoline prices and high consumer prices, a steep slowdown in China’s production shortages is both give-and-take away.
Write to Jacky Wong at [email protected]
Copyright © 2022 Dow Jones & Company, Inc. All rights reserved. 87990cbe856818d5eddac44c7b1cdeb8