By Jamie McGeever
ORLANDO, Florida, Dec 3 (Reuters) – Stocks rose while U.S. bond yields and the dollar fell on Wednesday, after surprisingly weak private sector jobs data increased the likelihood that the Federal Reserve will lower interest rates again next week.
More on that below. In my column today, I look at China’s seemingly incongruous twin strategy of allowing its currency to strengthen and boosting exports. There are good reasons to believe it will work.
If you have more time to read, here are a few articles I recommend to help you make sense of what happened in markets today.
Today’s Key Market Moves
Today’s Talking Points
* Bill yields tumble
If ultra short-dated U.S. T-Bill yields are the best proxy for near-term Fed rate expectations, the signals being sent out now could not be clearer. The one-month bill yield on Wednesday slumped nearly 8 basis points below 3.77%.
Remarkably, it has fallen nearly 25 basis points since Friday, meaning bills traders have effectively moved to fully price in a quarter-point rate cut from the Fed next week in the last four days.
* When low hiring drifts to firing
Expectations for a Fed rate cut next week have been strengthening for days, but Wednesday’s ADP jobs data looks to have sealed the deal. The 32,000 fall in private sector jobs in October was a surprise – economists had expected a slight rise – marking the worst month since early 2023.
Many economists and investors have long looked down on the ADP report, saying it bears little correlation to the broader official non-farm payrolls data. But post-government shutdown, perhaps ADP will be scrutinized more closely – and if low hiring morphs into outright firing, Houston, we have a problem.
* Small cap resilience
After rallying 5.5% last week – its best week in over a year – the Russell 2000 strongly outperformed again on Wednesday, surging nearly 2%, more than six times the benchmark S&P 500’s 0.3% rise.
This may seem a little surprising, given that the bulk of surprise ADP 32,000 job losses were reported by small businesses. With AI bubble fears refusing to die down, the rotation into small caps that has played out in recent months may have further to run.
Rising yuan won’t slow China’s export boom
China’s desire to keep its export growth engine roaring seems at odds with the steady appreciation of its currency. But these trends can continue to co-exist, highlighting the tenuous relationship between a country’s exchange rate and trade flows.
The People’s Bank of China has steered the yuan 3% higher since April to 7.07 per dollar, its strongest point in over a year. The currency is expected to stay on that path, with many analysts predicting the dollar will break below 7.00 yuan next year, perhaps to 6.60 yuan. That would imply a further 7% appreciation to levels last seen in 2022.
Yet one clear takeaway from the Communist Party leadership’s October planning meeting, or plenum, was Beijing’s reluctance to wean itself off its export-oriented growth model.
On the one hand, that makes sense given China’s domestic economy is still struggling with a burst property bubble, deflation and weak demand. Exports have contributed more than half of headline real GDP growth over the last two years, according to Goldman Sachs.
But shouldn’t a strengthening currency make China’s goods more expensive, and therefore uncompetitive, on the global market?
In theory, yes. But in practice, the robust yuan certainly doesn’t appear to be stemming the flow of China’s export volumes. Brad Setser, senior fellow at the Council on Foreign Relations and a long-standing China watcher, notes that China’s export volumes have risen a cumulative 40% since the end of 2019, while imports have increased just 1%.
ECONOMIES OF SCALE
The fact is, China’s goods are still relatively cheap. Indeed, on a real effective exchange rate (REER) basis – which adjusts for inflation differences between countries – the yuan is roughly at its weakest level in 15 years, down almost 20% since early 2022 and nearly 50% since 2012.
A housing crash, economic slump, capital flight and unfavorable interest rate differentials have accelerated the currency’s slide in recent years, and most analysts agree it is substantially undervalued.
What’s more, China can absorb a modest exchange rate appreciation because of its presence, expertise and dominance across global supply chains in a range of industries such as electric vehicles, solar panels and batteries. China is no longer the world’s cheap consumer goods factory, instead operating at the higher end of the economic, technological and strategic value chains.
“China’s sheer scale is very daunting,” says Marc Chandler, managing director at Bannockburn Capital Markets and another veteran China watcher.
Given the size of China’s footprint in many advanced sectors, how sensitive are its exports to fluctuations in its currency? Not very, it turns out.
Consider German automaker Volkswagen, which has invested billions in its plant in the Chinese city of Hefei. The company said last month that a new EV model in China can cost up to 50% less than elsewhere.
It will take more than another 5-10% rise in the yuan’s value to really dent that level of competitiveness.
WEAK FX, TRADE LINKS
Of course, the exchange rate is not the sole or even most important input influencing a country’s trade balance. Domestic demand, global growth, changes in commodity prices, and trade policy all play a role. And now, tariffs and other trade measures must be added to that mix.
Take Switzerland. The Swiss franc is currently near its strongest level in 15 years on a ‘REER’ basis. Yet Switzerland continues to post a substantial trade surplus, which has exceeded 10% of GDP in each of the last three calendar years.
On the flip side is Japan. The yen has been on the slide for years, and is currently hovering around its weakest levels ever in ‘REER’ terms, yet the country has posted a trade surplus every year for the past five years.
It looks like Beijing will continue its strategy of managed currency appreciation which, on the margins at least, should help cool simmering trade tensions with Washington and deflect criticism from competitor nations in Asia that China is muscling into its markets.
Though, ultimately, “muscling in” is exactly what China wants to do – and a firmer yuan shouldn’t stand in its way.
What could move markets tomorrow?
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Opinions expressed are those of the author. They do not reflect the views of Reuters News, which, under the Trust Principles, is committed to integrity, independence, and freedom from bias.
(By Jamie McGeever;)
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