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SPI Management Newsletter 17.11.23

Diminishing Inflation in the U.S. Surprises Economists, Boosts the Markets

U.S. inflation has taken a significant downturn, dropping to 3.2% in October, exceeding economists' expectations and marking the first decline in four months. This unexpected decrease from September's 3.7% rise has led to a notable reaction in financial markets, with Treasury yields plunging and Wall Street stocks seeing a notable upsurge.

In response to the new consumer price data, the yield on the two-year Treasury dropped to 4.83%, and the 10-year Treasury yield fell to a three-month low of 4.43%, before adjusting slightly to 4.45%. Correspondingly, the S&P 500 experienced a significant 1.9% rise, and the Nasdaq Composite increased by 2.4%. Concurrently, the dollar weakened against other major currencies, declining by 1.5%.

Economists have noted that this development indicates a positive direction for the Federal Reserve's policy, which has been striving to reduce inflation to the 2% target. Despite this, some financial leaders remain cautious, suggesting that the Federal Reserve might need to further intensify its efforts to control prices. This sentiment reflects the uncertainty surrounding the future trajectory of inflation and the Fed's next moves.

The UK and eurozone are also anticipating similar trends in inflation, with expectations of reduced price growth rates in October. This changing inflation landscape has fueled speculation that major central banks, including the Federal Reserve, European Central Bank, and the Bank of England, might pause their rate hikes.

The core inflation rate, which excludes volatile food and energy prices, also showed a slight decrease, further reinforcing market expectations that the Fed's policy rate has reached its peak. However, Federal Reserve Chair Jay Powell and other Fed officials have emphasized the need for caution, indicating that additional tightening of monetary policy might be necessary if inflation does not consistently decrease.

President Joe Biden has acknowledged the decrease in inflation, emphasizing its achievement without a significant rise in unemployment.

Tentative Steps Towards Reconciliation in U.S.-China Relations

The recent meeting between U.S. President Joe Biden and Chinese President Xi Jinping in San Francisco marked a pivotal moment in U.S.-China relations, indicating a potential thaw after years of tension that peaked with the 2018 trade war. While the progress remains cautious, this meeting could be the beginning of a significant reset in relations, which are currently at their most strained in four decades.

Key outcomes of their four-hour discussion include China's commitment to restore military communication channels, closed since Nancy Pelosi's Taiwan visit in August 2022, and its pledge to limit exports of chemicals used in fentanyl production, addressing a major U.S. public health crisis. Additionally, there seemed to be a softening of stances regarding Taiwan, with Xi expressing that China has no immediate military plans for the island, countering U.S. speculation of potential action by 2027.

Despite these positive steps, Biden's reference to Xi as a "dictator" during a press conference underscores the deep-seated mistrust and the fragility of these early stages of rapprochement. Nevertheless, both nations have strong incentives to pursue a more stable relationship.

For the U.S., improved relations with China are becoming increasingly critical amidst ongoing conflicts in Ukraine and the Middle East. The U.S. perceives China as potentially influential in de-escalating tensions, particularly in the Middle East. Conversely, China faces its own set of challenges, including economic slowdowns and a decline in foreign investment, leading Xi to actively court the U.S. business community and underscore China's market opportunities.

Despite these overtures, considerable hurdles remain. Western investment in China may continue to lag if Beijing persists with actions perceived as hostile, like raids on U.S. businesses. The U.S. is also closely monitoring China's commitment to controlling fentanyl precursor exports. While the resumption of military communication is a positive step, it's just the beginning of a long journey towards rebuilding trust. Unexpected incidents like the Chinese "spy" balloon over the U.S., which previously derailed diplomatic efforts, might still pose challenges.

Adapted from WSJ, FT, NYT, Reuters, CNBC, `Bloomberg

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