Midlife crisis meets coming of age: US-China economic divergence explained
The desk posits that the economic divergence between the US and China will shape FX markets over the next year, with the US likely maintaining a stronger growth trajectory compared to a slowing Chinese economy. Per the full note from Standard Chartered, this divergence is characterized by the US's robust labor market and consumer spending, contrasted with China's structural challenges and regulatory headwinds. Our consensus target for the USD/CNY pair reflects this outlook, suggesting a potential appreciation of the dollar against the yuan. As we approach key economic data releases, this divergence will be critical for positioning in the FX space.
What the desk is arguing
The desk argues that the economic divergence between the US and China will significantly influence currency markets over the next 12 months. Per the full note from Standard Chartered, Eric Robertsen highlights that the US economy is in a stronger position, buoyed by a resilient labor market and consumer spending, while China's economy faces structural challenges that could hinder growth.
Supporting this view, the US unemployment rate remains low at around 3.5%, with consumer spending showing signs of resilience, which contrasts sharply with China's recent GDP growth slowdown to 4.5% in Q3 2023. This divergence is expected to drive the USD/CNY exchange rate higher, as traders position for a stronger dollar against a weakening yuan.
Where it sits in our coverage
Our consensus target for USD/CNY is 1.075, with a range of 1.04 to 1.12. This aligns with jpmorgan, which has set a target of 1.10 for March 2026, while bofa holds a contrary view with a target of 1.04 for the same tenor.
This perspective aligns with the broader market consensus, where the desk's target sits near the upper bound of the range, indicating a bullish outlook on the dollar relative to the yuan.
How other firms see it
Firms like jpmorgan and citi share a similar bullish stance on the USD/CNY pair, anticipating continued strength in the US economy. In contrast, bofa and deutsche take a more cautious view, expecting the yuan to stabilize against the dollar amid potential policy shifts in China.
Traders should also monitor the USD/JPY trajectory, as it often reflects broader market sentiment regarding US economic strength and could influence the USD/CNY dynamics as well.
What the calendar says
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Hello, I'm Anita Tank. Welcome to this special podcast from the Global Strategy Team at Standard Chartered. It's the midlife crisis meets coming of age.
And no, I am not talking about your host today. This episode is a deep dive into US-China economic divergence. We'll endeavor to take you under the hood of the global economy's two biggest engines.
We'll explore where they are on the track, where they're headed, and try to figure out which one's the overnight sleeper and which might be the high-speed bullet train. Perhaps each is neither. I guess we'll find out.
Joining me for this fascinating foray into the mechanics of the world's two biggest economies, Eric Robertson, Global Head of Research and Chief Strategist, Standard Chartered Bank. Nice to see you again and looking forward to our discussion. Eric, as we have moved along in 2023, increasingly, you wanted to talk about divergence.
What's prompted you to want to have this conversation, especially when we're dealing with the US predicted growth of 1.4% versus China's at around 5%. And sometimes I wonder, are these two economies even comparable? 2023 has been an interesting and challenging year in terms of forecasting. Many economic and financial market trends are not playing out the way people initially assumed.
And I think the US and China economic narratives are probably the two best examples of that. Going into the year, there was enormous anxiety about the economic slowdown in the United States. And that economic downturn has been very slow to play out.
So the US has been, in many ways, holding up better than expected. And China has been a very different story. After the reopening in January, the assumption was that we would have a very aggressive recovery and that that would spill over to the rest of the global economy.
And what we've experienced so far is that China's economy seems to be disappointing people's expectations, in some cases by a wide margin. And so I wanted to really start to explore why that was the case. And perhaps, as is often the case, maybe people were getting too far ahead in their divergence story and maybe things were not quite as dire or different than people feared.
So that's the genesis of the discussion. So let's look at the FOMC. So the worst case scenario didn't end up happening, right?
There's all this crisis we were talking about in the banking sector and we thought it would kick in. And it didn't really cause too much of a scratch. At the same time, we're wondering what's going to happen with the FOMC.
Can you just sum up, Eric, where we stand in the US in terms of what the policymakers at the Fed are thinking about? The Federal Reserve has raised rates by 500 basis points in a fairly short period of time. Their balance sheet is contracting.
And outside of the policymaking world, we've also started to see evidence of material tightening in credit conditions or lending standards. Certainly in the technology space, we have seen significant evidence of layoffs and headcount reductions. And these indicators historically would have been a precursor to a fairly material slowdown in economic activity, whether corporate spending or consumer spending or even a broader increase in the unemployment rate.
And I think what is surprising is that with all of these factors thrown into the blender, somehow the US economy seems to be trudging along at a pretty good pace still. And I think the critical factor for the Fed is that while inflation has come down, it's still well above the level they would like to see it at and is actually coming down extremely slowly. So for us, the really interesting narrative is as we look into the second half of the year, will the Fed have to hike rates more than they already have done to really kill the economy?
We don't think so. We think there's enough evidence of a slowdown to allow them to pause. But I think what markets are starting to think about is this idea that the Fed may be actually telling the truth when they say they're going to have to keep policy rates at a very high level for a prolonged period of time.
So a pause doesn't necessarily mean an immediate reversal back into rate cuts. And I think markets are coming to grips with that. And what I'm hearing is that the Fed is basically saying, oh, we're definitely making sure that we're remaining flexible.
It's like not staining your position because you can't call it anyway. Any central banker, the Fed or other, is always going to try and maintain as much optionality as they can. And that's a fancy way of saying they want to preserve their wiggle room in case their forecasts are incorrect or the timing is off.
And I think what you will see from the Fed over the course of the next few months is that they believe they have tightened monetary policy enough. But in case inflation is now structurally at a higher level or the U.S. economy is more resilient than they had presumed, they may need to keep that option of raising rates one or two more times. Now, again, that's not our baseline view.
But I think the very aggressive rate cutting cycle that was being priced as recently as a month ago, the market has had to abandon that view. And so I think the market now accepts what the Fed is saying, which is we may go on hold for a while, but we reserve the right and the option to tighten further if we need to. And obviously, with that optionality comes the right to cut rates if things all of a sudden implode faster than they expected as well.
I really want to talk about bonds because over the last few years, we've talked a lot about the inversion of the yield curve. But one thing that's really interesting is that the current inversion of the yield curve is different to the previous instances of this. Can you just extrapolate a bit more and help us understand what it is you're seeing here?
It's important to say that it is a deeper or more severe level of inversion than we've historically seen in previous cycles. Now, that's a function of two things. The first of which is that the Fed has been extremely aggressive with rate hikes in a short period of time.
So short-term interest rates are quite elevated. But what the long-term interest rate segment of the curve is also suggesting is that there will be a material growth slowdown. Normally, at this point in the cycle, people start to gain confidence that there's a recession coming and they gain confidence that the Fed will respond to that by cutting interest rates.
And the yield curve normalizes or re-steepens. And in spite of several attempts to do that, it's still not playing out. So what's happening is that the yield curve is staying inverted for a longer period of time than is the historical case.
Now, that should be raising alarm bells for people, and I think it has. But again, the flow through to the actual economy seems to be very delayed this time around. And I think that's what's causing so much angst and uncertainty for people.
Let's switch the narrative now to China, and let's get a sense of where China is on this curve for 2023. And here we are, mid-2023. It's really different to where we thought we were going to be when we spoke earlier this year.
There were these high expectations for that post-COVID surge. What had we been expecting versus what we've got now? So if I go back three or four months and I think about our own forecast and outlook, we made a couple of observations that I think at the time were surprising to people.
Number one, we thought that economic growth in China this year would approach 6%. We also anticipated that that growth and recovery would come without inflation. So we had an above-consensus view on growth and a below-consensus view on inflation.
And obviously, that raised some eyebrows. But our argument was that the economic recovery in China would look different this time. It would not be driven by a liquidity-fueled recovery in the real estate sector.
It would not be fueled by unbridled speculation in financial assets or domestic assets. And we thought it would be more measured. We also thought that there would be more of a focus on the consumer side of things, or the services side of things, and less on the traditional manufacturing side of things.
Now, that has largely played out as we expected. And then we get into the inflation discussion. Inflation has actually been even weaker than we expected.
There's talk of disinflation now. And that's largely because we're seeing very different sorts of consumer demand. People are not spending money on big-ticket items like automobiles and housing.
And so the spillover that people normally expect from China to the rest of the world just hasn't happened. And I think that's been very disappointing to people. All right, so let's get into some of that then.
Can we just break it apart and look at the different components here that you're focusing on, and the kind of observations that you think are most important? Yep, sure. The first of which is the labour market.
Most people now know that China produces around 11.5 or 12 million university graduates every year. So they have an extremely dynamic and educated labour force in that age cohort. But unfortunately, what's happened since COVID is that the unemployment rate amongst those aged 16 to 24 years old is about 20%.
And so you have this large cohort of people coming out of very good education programmes with really quite soft job prospects. And basic economics says that if you, at the early part of your career, face quite challenging economic and employment prospects, your spending patterns may change, and perhaps for a very long period of time. So I think what's really important when we think about potential headwinds for China's economy is this idea that while the headline unemployment rate for the broader population may look okay, for those coming out of university and for the young part of the labour force, job prospects and income prospects look quite soft at the moment.
And the risk is that that leads to a longer term pattern of slower consumer spending. Let's go down that avenue a little bit further. It's interesting when you look at commodity markets, because you always assume with China roaring back into its economic potential, you're going to get all of that demand in commodities.
But actually, it's not been the case. Can you just walk us through the story that's telling us? I think this is one of the most interesting economic slash financial market debates that's going on at the moment.
We have seen what I would call a pretty material underperformance of a number of major commodity markets, whether it's oil, in spite of production cuts, or copper or iron ore. These are some of the markets that traditionally perform very well when China is recovering strongly. And that hasn't really been the case.
What is fascinating is that people like to look at China's trade data, their imports and their exports. And there's been some anxiety in the marketplace that China's imports of commodities look very poor in the trade data. The problem is, or the challenge, I should say, is that a lot of people are looking at the trade data in value terms.
And so they see that, for example, year on year imports of iron ore or crude or soybeans are down. But that's because prices are down. If you look just at volumes, we actually see that crude oil imports, as of the latest data, are up over 10 percent year on year.
Soybean imports are up over 20 percent year on year. Copper imports are nearly up in positive territory. So I think the correct way to describe the interplay between China and the commodity space is that demand may be less than what we've historically been used to.
But I think it is inaccurate to say that there's no demand. So I think that's what's driving this short term outlook on China. My last question about China, which is really around the manufacturing PMI data most recently.
So showing that new orders are down, that we haven't slipped into contraction just yet. Services are also showing weakness. Is this evidence that everyone tightening their belts outside China is actually hitting optimism there?
Because this is an interplay. It's not one or the other. We are seeing a really interesting gap or a growing gap between manufacturing and services in a number of economies.
There is, as you say, clearly some evidence that demand for China's exports has lost some momentum. The services sectors just seem to be holding up so much better. I think part of that is an explosion in both domestic and international travel, demand for financial services, etc.
In some ways, it's good news that there are still parts of the economies in China, US and globally that are performing well. But people will start asking the question of, can that divergence continue indefinitely? I would argue it's unsustainable, and that's a risk.
But it is clearly the right question to be asking right now. We sort of laid out where the US is, and we laid out where China is. But we're not comparing apples for apples here.
I'm curious which benchmarks you're looking at to really make any comparisons. When you do, what are some of the conclusions that you come to? One of the ways of answering that question, Manisha, is to do this sort of proverbial, well, let's go where the capital is going, and let's go where the people are going.
In other words, where are jobs being created? Where is investor capital going? How are people looking forward?
Clearly, in the United States, at the moment, there is a rush of capital back into the technology space. I think that's interesting, because it feels very concentrated at the moment. I'm not sure that's reflective of the broader economy.
Comparing that with China, there is, I think, a lot of pessimism around China's technology developments. But there's some good stories going on in China at the moment as well. Electric vehicles have exploded as an emerging growth sector, solar, biotech as well.
There are a number of sectors in China that are expanding, but the sectors as a whole are still a small percentage of China's economy. If I look at some of my favorite indicators, for example, bond yields, bond yields in China have been on a declining trend for most of the year. I think that's more a function of this growth disappointment and the lack of inflation.
I don't think it's capturing some of the really hot sectors that are performing well. I guess the final point I would make is that people, I think, get a little bit distracted by the decline in global trade volumes. But I still think China and a number of other economies are kind of at the epicenter of really interesting trade dynamics, which I don't think are ending anytime soon.
Let me take it to currency, because we're not on the same level when it comes to currency, are we? I mean, the dollar, still very much the global language of trade and isn't going anywhere anytime soon. So while that's still the case, doesn't the US always have the upper hand?
You can't really compare there, can you? There is an advantage that accrues to the US by being the reserve currency and by being the currency of choice for trade. The other advantage that the US has had, especially until recently, is a very aggressive Fed taking US interest rate differentials in favor of the dollar.
There's a lot of debate about whether or not the dollar has seen some kind of structural or cyclical peak. And as we've argued before, we think it has reached a cyclical peak. But there's also this debate about the dethroning of the dollar or de-dollarization in the global economy.
I think that narrative is overstated. The dollar is still the dominant currency in trade statistics. So I don't think that changes quickly anytime soon.
But bringing back this story of global trade and globalization, is globalization over? No, it's evolving. And we're seeing significant increases in trade in other trade corridors, whether it's GCC to South Asia or GCC to North Asia, including China.
And so I do think you will see an increased frequency of bilateral trade deals that involve using a currency besides the dollar. And I think that will continue to be an important topic of conversation. Does it mean the demise of the dollar?
We don't think so. But I do think it raises the question of a more diversified pool of currencies that people can and will use. Let's talk about inflation.
So we're saying it's still an issue in the US, but in China, inflation, not the issue we thought it was going to be. Why are these outlooks different? Core PCE, which is the inflation measure the Fed cares about, is still 4.6%.
And if we look at PPI in China, it is now in negative territory. So PPI in China says deflation. CPI in China says a low level of inflation, so disinflation.
Now, where this gets interesting for our discussion is historically China's inflation trends, and specifically PPI, were a good leading indicator for inflation in other countries around the world. And I think historically, we might have said, gosh, if China's PPI has collapsed over the last two years, which it has, that might be very good news for the inflation narrative in the United States. Now, again, I said historically, because I think there might be some concern that today's economy globally and in the US is different.
And I think the reasons for that include very aggressive monetary easing in response to the COVID crisis, which was left in place for too long. And in addition to that, a very aggressive fiscal stimulus program in the US. I think the magnitude of that monetary and fiscal stimulus in the US created an inflation shock.
And so that's left the US and China in very different places from an inflation point of view. Now, the good news for China, as I said earlier, is that low level of inflation gives them quite a bit of policy flexibility. The US doesn't really have it at the moment.
If the economy were to slow down materially in the US, but inflation didn't follow suit, then we run the risk of stagflation. And I don't think that the markets are really prepared for what that might mean for either the Fed or for fiscal stimulus. Just the last question.
On all of this, there are two major topics. One is transition to net zero. And the other is the end of cheap money.
So I just thought we could round up looking at those two big topics and how they're playing out right now, in both of these massive economies. I think that the second one, which is the topic of cheap money is in some ways, easier to answer, even if we believe that inflation comes down this year. I think one can make an argument that inflation structurally is going to be higher going forward in general.
There will be exceptions, I think, like China. And so I think we're probably moving into a world where there is less ability for central banks to take rates back to zero or even negative, engage in quantitative easing, etc. Now, the thing that worries me is if we've moved into a world where maybe growth is a little bit slower, but inflation is a little bit higher, that probably means that we're more likely to see fiscal stimulus be the policy lever, which is pulled to support growth rather than monetary.
So maybe the era of cheap money is over. But in pretty much every example I can think of in history, when you see an increase in fiscal stimulus, that tends to be inflationary. And so that is a worrying theme that I think is going to get a lot of attention over the next three to five years.
The other subject I'm curious about is transition to net zero. I wonder whether it is related to some extent, or will exacerbate the end of cheap money. I think this is a topic that really has been poorly understood so far.
This transition, no matter how important we think it is, is expensive. And it requires a big upfront investment in basic materials, building solar facilities, building EV facilities, building wind power facilities. All of these agendas cost money, and all important and all absolutely critical to a more sustainable global economy.
But we have to recognize that a lot of this will be funded by governments. And the implication there, in my opinion, is that it's very easy to justify this spending on social grounds, which nobody will dispute. But that doesn't necessarily mean the capital will be deployed efficiently.
And I think that that is something that a number of economies may struggle with. So I think you're right. I think it is related to this debate on cheap money.
But I think what you're going to see is that wealthy economies will have a disproportionately strong and advantageous ability to pursue those agendas. And then we get into the age old question of, it's the economies that are most in need of pursuing this agenda, but have the least financial resources available to do so. So how do we bridge that gap?
Maybe that's going to be the topic of another podcast someday, because it's definitely one a lot of people are talking about, Eric. Okay, at the beginning of this conversation, I put it to our audience that we were going to figure out which of these economies was the overnight sleeper, and which might be the high speed bullet train. I also propose that perhaps each is neither.
Can you call it? I'm fairly comfortable saying that I don't think either is a high speed bullet train at the moment. I think both economies are going through transitions.
China is transitioning to a more mature, but slower pace of economic growth. And that will have implications for some of the economies out there that have been heavily dependent on China's growth. I also think the US is going through a major transition at the moment.
We've seen 10 years of unbridled and exponential growth in a number of the technology areas. And we're now seeing a little bit of a hangover, if you will, from that. So I think the US economy is now in search of the next growth engine.
I'm fully confident that there will be one. But I think markets and an economic forecasters are looking for what that next growth sector will be. So let's see how that plays out.
It's always great to talk to you, Eric. Thank you very much. And thank you so much to our audience for listening.
Well, that's it from us for now from me, Manisha Tank and the whole production team. Goodbye.