MNI INTERVIEW: China's Reopening Risks A More Hawkish Fed

China's reopening risks an inflationary impulse through commodity and raw material prices that could keep interest rates in the U.S. elevated for longer or keep the Federal Reserve raising rates higher than previously thought, National Association for Business Economics' Jack Kleinhenz told MNI.

Almost half of respondents in the latest NABE Outlook Survey "believe that there will be some type of inflationary effect from China's reopening, suggesting that there will be greater demand on world resources, whether it be commodities or the purchase of goods and services," said Kleinhenz, also chief economist for the National Retail Federation. "They'll have increased demand for goods from around the world and put pressure on inputs."

In turn, that would prompt the Fed to maintain a hawkish policy stance, he said. Over half in the survey said the Fed would keep interest rates elevated for longer if China's reopening causes faster U.S. inflation, while 44% said the central bank would continue raising interest rates.

The NABE panel expects a meaningful disinflationary trend, but expectations are widely dispersed among the 48 professional forecasters, with core PCE views ranging from 4.1% to 1.9% in 2023 and 3.7% to 1.6% in 2024. The median sees core PCE inflation slowing to 3.0% in 2023 and 2.2% in 2024.

Those views on the U.S. inflation path are likely higher now after the government reported Friday that core PCE inflation rose 0.6% in January and 4.7% on the year, slightly higher than economists’ expectations, he said in an interview.

Roughly half of survey respondents expected core PCE inflation to reach the Fed's target in 2025 or later. (See: MNI INTERVIEW: US Inflation Could Take Many Years To Reach 2%)

RECESSION DELAYED

Fed officials and staff mentioned the possible ripple effects from China in the summary of the February FOMC meeting that was released last week. The central bank is expected to raise interest rates by a quarter of a percentage point at its March 21-22 policy meeting to a range of 4.75% to 5%, but a couple of Fed presidents have said a 50-basis-point move should not be ruled out.

"Our survey really suggests that there would be increases in rate hikes, and that the Fed generally would stay pretty much at that level for the time being," Kleinhenz said. "Where there is a real difference of opinion is on how the economy is performing under the Fed and how monetary policy will work its way through the economy."

NABE respondents believe the three most likely metrics guiding the Fed’s decision to pause include material actual slowing in core services excluding housing PCE inflation, slowing in core PCE inflation, and if the Fed is generally confident that inflation would continue to slow to target in 2024, he said. Expectations for the Fed to begin cutting rates largely center around the turn of the next year.

"The panelists expect tepid US growth in 2023 and a rebound in 2024. But expectations still remain concerning a recession," Kleinhenz said. Projections for non-farm employment growth were revised upward and the majority of respondents doubt that the unemployment rate will exceed 5%.

Views about GDP growth are disperse with the lowest five responses and the highest five responses for 2023 ranging from -1.3% to 1.9% in 2023 and from 0.1% to 2.6% in 2024. The median was 0.3% in 2023 and 1.9% in 2024.

The NABE survey was conducted February 3-10.