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Good news were bad news yesterday and they even wiped out the optimism that Nvidia initially created around AI with the announcement of new products. When Jensen Huang took stage at the opening of the CES this week, he didn’t only show off the company’s new products like the new $3000 personal AI supercomputer and its new gaming chip created with the same design than the now-famous Blackwell chip, but he also spit out a lot of new partnerships with advanced warehouses and autonomous driving carmakers around the world to improve their devices with their powerful AI chips - among them Toyota which gained yesterday and today in Tokyo, Uber that saw its share price jump more than 3% at the open, Accenture that saw its own share price jump more than 3% as well compared to the closing level of the day before, and Aurora which saw its share price jump up to 72%. Most of the gains were given back during the session, the selloff being put on the back of a broad-based market selloff. Nvidia hit a fresh record high before diving more than 6%. Some said that the new projects demanded long time to bring in concrete revenues, and many preferred taking their profit in their pockets and walk away.

But beyond the price action in Nvidia and growing number of related stocks, the new year begins strongly on how the AI technologies will affect – and improve – the existing tools for many technology companies beyond the Magnificent 7 and that – to me – is almost more exciting than how much more money Nvidia could make. In all cases, it looks like the AI talk is NOT ready to be over just yet. On the contrary, we are only getting started.
Zooming out

News were much less exciting on the economic data front than it has been on the AI front. The US released a set of higher-than-expected ISM data, suggesting that non-manufacturing activity was better than expected in December – in contradiction to the S&P’s PMI data released a day before. But what really dampened the market mood was that prices paid by companies unexpectedly - and meaningfully - jumped to the highest levels since 2023. Separately, JOLTS data hinted at an unexpected jump in job openings in November to above 8 mio jobs openings. The better-than-expected US data fuelled the hawkish Federal Reserve (Fed) expectations, pushed the US yields higher and kicked the expectation of the next Fed cut further down the road. A May cut is now a coin flip, and many believe that the Fed may want to wait until June to announce its next rate cut.
In the FX

The US dollar rebounded against most majors as the latest US data fuelled the Fed hawks. Due today, the ADP report is expected to print a relatively soft number of new private job additions last month – a consensus of analyst estimates on Bloomberg expects the US economy to have added just below 140K new private jobs in December down from 146K added a month before. A soft ADP print should easily scale back the hawkish Fed expectations – that may have gone a bit ahead of themselves, but a stronger-than-expected figure will certainly worsen the bond selloff.

Note that, the hawkish Fed expectations is not necessarily the root cause of the US bond selloff; the fear that the US government spending under Trump will explode is a bigger issue. Since the Fed started cutting the interest rates in September, the US yields only kept climbing. The US 10-year yield was near 3.60-3.65% into the Fed’s first rate cut in September and has risen more than a full percentage point since then... which is – yes – a bit disquieting. Also, the yield curve steepened a bit too fast. And the rapidly rising yields despite the Fed calling the end of its post-pandemic tightening cycle now sent the gap between the S&P500 earnings yield and the BBB bond yield to a deepest negative level since 2008. In plain English, the BBB-rated corporate bonds today pay less return than the riskier equity investments. And that’s an anomaly: it means that either the market is in a bubble or the credit risk is rising meaningfully. Presently, we could suspect both. The S&P500 fell more than 1% yesterday, while Nasdaq dived nearly 1.80%. The Dow Jones retreated 0.42%, mid cap stocks lost 0.61% and small caps retreated 0.74%.

In Europe, the CPI reading went better than I expected. The latest CPI update from the Eurozone confirmed the rising price pressures in the December print, yet the number came in line with expectations as softer-than-expected figures in Italy and France compensated for the jump in German prices. The retreat in nat gas prices also improved the dovish ECB expectations on Tuesday and kept the upside in the EURUSD capped into the 1.0434 level. The pair tested the peak of the day before but failed to clear it as the combination of more dovish European Central Bank (ECB) expectations and more hawkish Fed expectations sent the pair below the 1.04 level.

Across the Channel, the UK’s 30-year gilt yield advanced to the highest level since 1998. Yes you are reading that right, the 30-year gilt yield hit the highest level since 1998 fuelling the expectation that the country will need more tax raises to finance its debt... Such a move would mean a bigger pain before any gain on the government’s spending plans. And that’s weighing on Cable right now, along with a broadly stronger US dollar. The pound remains bid against the euro, however, on expectation that the ECB will deploy a softer monetary policy than the Bank of England (BoE). And the latter – the dovish ECB expectations – remains well supportive of the Stoxx 600 which cleared the 100 and 200-DMA yesterday. The MACD indicator turned positive for the first time since 18th of December, hinting that momentum traders could continue to push the European stock valuations higher.

In focus today

From the US, ADP's private sector employment report for December will be released in the afternoon, and FOMC's December minutes are due for release in the evening. The former will give early hints of what to expect from Friday's key Jobs Report, while markets will keep a close eye on the latter for details on discussions that led to the hawkish stance at the meeting.

Today, focus is on German industrial production data for November - in which the trend has been declining in previous releases.

At 08:00 CET we will get the Swedish flash inflation estimates for December. We see CPIF at 1.7% y/y and CPIF ex energy at 2.3 % y/y. This is 0.2 pp. below and 0.1 pp. above Riksbank's forecasts. This month all core price components are expected to have contributed positively to inflation.

Economic and market news

What happened overnight

On the political front, incoming US President Donald Trump reiterated that he would not rule out any economic or military action to gain control of the Panama Canal and Greenland. With Denmark resisting his offer to acquire Greenland, Trump, also, for the first time, threatened to impose tariffs on Denmark. Yesterday Donald Trump Jr. visited Greenland.

What happened yesterday

In the US, the ISM services for December was stronger than expected at 54.1 (cons: 53.3, prior: 52.1). The uptick is largely attributed to the services priced paid sub-index, which increased to 64.4 from 58.2 - its highest level since February 2023. However, it is worth mentioning that the similar PMI index has been declining, suggesting mixed signals from the ISM print. Business activity climbed higher, though other sub-components were little changed.

Akin to the ISM data, the JOLTs report for November was a bit mixed. While job openings were higher than expected, printing 8.1m (cons: 7.7m) - the highest since last May, hiring slowed down coupled with involuntary layoffs crawling slightly higher. Suffice it to say, the report painted a picture of labour demand at healthy levels. Coupling both data releases, the rather hawkish market reaction with a stronger USD and USD rates trending higher is natural.

In the euro area, HICP inflation for December ticked up to 2.4% y/y as widely expected, mainly due to base effects on energy inflation, while core inflation stayed at 2.7% y/y. Looking at monthly data, core services inflation was on the high side, increasing 0.30% m/m SA. However, this also comes after a very low print in November, indicating that momentum remains broadly unchanged. Core goods inflation stayed very low in December like the previous many months and food inflation now declined again. All in all, data shows that the disinflationary trend in underlying inflation continued in December, which is positive for the ECB in their effort to bring down inflation. Going forward, we expect headline inflation to decline in Q1 2025 - and at the same time we project that base effects on services prices will also pull core inflation lower combined.

Turning to labour markets, the unemployment rate remained at its historically low level of 6.3% in November - attributed to a decline in the number of unemployed persons by 40k to the lowest number ever recorded. Combined with rising employment in Q3 the hard data thus continues to show a resilient labour market in the euro area in contrast to softening survey indicators.

In Switzerland, inflation for December printed broadly in line with expectations, aligning with the SNB's Q4 2024 forecast of 0.7% y/y. Headline was 0.6% y/y (cons: 0.6%, prior: 0.7%), while core was 0.7% y/y (cons: 0.8%, prior: 0.9%). The monthly momentum in seasonally adjusted terms showed further easing at 0.07% in headline and 0.05% in core with disinflation in the domestic components. While this should set the scene for the SNB delivering another cut in March, as we and markets expect, there are still two inflation reports before the meeting on 20 March. We remain positive on the CHF amid a backdrop of narrowing rate differentials to the ECB and fundamentals.

Equities: Global equities declined yesterday as US equities fell, dragging down global indices. Consequently, there was notable outperformance in Europe. Mainstream financial media seem to be attributing the downturn to macroeconomic data, particularly inflation-related figures, as yields continued to rise. This assessment is perhaps fair, as we noted this phenomenon yesterday. However, a strong set of macroeconomic data, even with a slightly high price component in the ISM Non-Manufacturing Survey, should still be viewed positively.

When markets are exuberant, and we are reminded of a challenge we've recently faced, such as inflation, it often leads to profit-taking. This is also why we did not see the typical yield-sensitive sectors losing the most yesterday, but rather the growth and tech sectors, which have been recent winners, being the losers yesterday. In the US yesterday, the Dow was down 0.6%, S&P 500 fell by 1.2%, Nasdaq decreased by 1.9%, and Russell 2000 dropped by 1.1%. This morning, most Asian markets are lower, along with European futures, although US futures are higher.

FI: The European inflation print did not leave clues for the near-term policy outlook where ECB is set to deliver a 25bp rate cut at the meeting later this month, and thus rates traded sideways in the morning. Markets are pricing roughly 100bp worth of ECB rate cuts this year. Better than anticipated US data, with JOLTS and ISM services beating expectations, led to a US driven sell-off across rates driven by the long-end in a bearish steepening move. Markets are now pricing and implied probability of 30% for higher SOFR rates by the end of the year.

FX: US yields climbed, and equities declined as US macro, including the ISM, showed a strong reading. The greenback performed, with EUR/USD breaching below 1.0350 whereas NOK/SEK found itself touching above 0.9800 amid poor SEK performance. A soft twist to the Swiss December inflation print prompted an initial move higher in EUR/CHF, although this faded later in the session.

Key Highlights

• Gold started a fresh upward move above the $2,625 resistance.
• A key bullish trend line is forming with support at $2,620 on the 4-hour chart.
• Oil prices could continue to rise if there is a close above the $75.00 resistance.
• The US ADP employment could change by 140K in Dec 2024.

Gold Price Technical Analysis

Gold prices remained well-bid near the $2,600 zone against the US Dollar. The price formed a base and started a fresh increase above $2,610 and $2,615.

The 4-hour chart of XAU/USD indicates that the price even climbed above $2,620 to move into a positive zone. There was a clear move above the 50% Fib retracement level of the downward move from the $2,726 swing high to the $2,582 low.

The price surpassed the 100 Simple Moving Average (red, 4 hours) and the 200 Simple Moving Average (green, 4 hours). On the upside, immediate resistance is near the $2,670 level or the 61.8% Fib retracement level of the downward move from the $2,726 swing high to the $2,582 low.

The next major resistance sits near the $2,692 level. A clear move above the $2,692 resistance could open the doors for more upsides. The next major resistance could be $2,700, above which the price could rally toward the $2,720 level.

On the downside, initial support is near the $2,635 level. The first key support is near $2,620. There is also a bullish trend line forming with support at $2,620 on the same chart.

The next major support is near the $2,600 level. The main support is now $2,580. A downside break below the $2,580 support might call for more downsides. The next major support is near the $2,550 level.

Looking at Oil, there was a decent increase, and the bulls might aim for a close above the $75.00 resistance level.

Economic Releases to Watch Today

• US ADP Employment Change for Dec 2024 - Forecast 140K, versus 146K previous.
• FOMC Meeting Minutes.

Short Term Elliott Wave view in Nasdaq (NQ) suggests rally to 22454.7 ended wave ((3)). Pullback in wave ((4)) is now in progress as a zigzag Elliott Wave structure. Down from wave ((3)), wave 1 ended at 22206 and rally in wave 2 ended at 22387.75. The Index resumed lower in wave 3 towards 21311 and rally in wave 4 ended at 21697.75. Final leg wave 5 lower ended at 21006.5 which completed wave (A). Rally in wave (B) unfolded as a zigzag structure. Up from wave (A), wave A ended at 21812.25 and wave B ended at 21476.75. Wave C higher ended at 22111.25 which completed wave (B) in higher degree.

The Index has turned lower in wave (C). Down from wave (B), wave ((i)) ended at 21870.25 and wave ((ii)) ended at 22076.25. Wave ((iii)) lower ended at 21253 and rally in wave ((iv)) ended at 21571. Wave ((v)) lower ended at 21121.75 which completed wave 1 in higher degree. Rally in wave 2 unfolded as an expanded flat where wave ((a)) ended at 21490.5 and wave ((b)) ended at 20983.75. Wave ((c)) higher ended at 21896.75 which completed wave 2 in higher degree. The Index then turns lower again in wave 3. Near term, as far as pivot at 22454.77 high stays intact, expect rally to fail in 3, 7, or 11 swing for further downside.

Nasdaq (NQ) 60 Minutes Elliott Wave Chart

Nasdaq (NQ) Elliott Wave Video

https://www.youtube.com/watch?v=9B8EsAO7G70

• Stronger-than-expected US economic data (JOLTs job openings and ISM Services Index) weigh on US Indices.
• Markets exhibited sensitivity to monetary policy expectations and potential volatility, with sector performance varying.
• Technical analysis of the S&P 500 suggests a range-bound market with key support and resistance levels identified.
• Upcoming non-farm payrolls and Fed meeting minutes releases are expected to further influence market volatility.

US Indices and stocks are on course to end two consecutive days of gains following a batch of strong US data. The data fueled speculation that any potential rate cuts in 2025 would come later in the year, evidenced by the fact that traders no longer fully price in a Fed rate cut before July.

US ISM Services and JOLTs Data Smash Estimates

The US Labor Department reported 8.098 million job openings in November, higher than the 7.7 million economists surveyed by Reuters had expected.

Additionally, an ISM survey showed that services activity in December remained strong with a reading of 54.1, beating the expected 53.3 and improving from the previous month.

The robust data has added to expectations around rate cuts from the Federal Reserve this year.

Markets Remain Sensitive to Monetary Policy Expectations

If today’s data confirmed anything it is that markets will remain sensitive to changes in monetary policy expectations moving forward. There is also the belief that extremely high valuations have left markets and US stocks more sensitive to volatility shocks.

However despite these high valuations and a stellar 2024, the election of Donald Trump as well as historical data appear to support further gains.

Bulls rejoice when the S&P 500 posts a 20% annual return. Historically, the following year has seen positive returns 81% of the time, with an average gain of 10.6% since 1950.

Source: Isabelnet, Carson Research (click to enlarge)

Winners and Losers

Looking at the sector performance today as well as individual winners and losers thus far, healthcare stocks saw a 1% rise, leading gains in the S&P 500 sectors. Vaccine makers like Moderna, Novavax, and Pfizer jumped due to rising worries about bird flu.

Tesla shares fell 2.9% after BofA Global Research downgraded the stock from “buy” to “neutral,” which also impacted the consumer discretionary sector.

Micron Technology rose 5% following comments from Nvidia’s CEO, Jensen Huang, that the company is supplying memory for Nvidia’s new GeForce RTX 50 Blackwell gaming chips.

Big banks performed well, with Citigroup increasing by 0.3% after positive coverage from Truist Securities, and Bank of America gaining 0.6% thanks to favorable ratings from several analysts.

Source: LSEG (click to enlarge)

The Week Ahead

This week, the main highlights are the important non-farm payrolls report and the release of the Fed’s December meeting minutes due on Wednesday and Friday respectively.

Judging by today’s reaction, volatility seems to be a given. The bigger question right now is whether any moves to the downside remain sustainable or are they just opportunities for potential longs to get involved?

Technical Analysis

S&P 500

From a technical standpoint, the S&P 500 remains in somewhat of a range having broken the previous bullish structure that was in play.

The overall price action picture does remain bearish following the daily candle close on December 18, 2024. Since then the Index has printed a lower high but failed to print a lower low.

This could be seen as a sign of the bullish pressure and overall buoyant mood toward US stocks in general.

More recently the index has failed to break the 6025 swing high or the 5828 swing low, keeping it confined in a +- 100 point range.

A break of the swing high at 6025 could facilitate a move toward the all time just above and potentially the next key area on the upside around 6170. (based on a triangle pattern breakout yet to be fulfilled).

A continuation of today’s bearish move may find support at 5910 and 5828 which rests just above the 100-day MA, making this a key area of support.

A break of this key support level could pave the way for a deeper retracement toward the 5700 swing low from October 31, 2024.

S&P 500 Daily Chart, January 7, 2025

Source: TradingView (click to enlarge) 

Support

• 5910
• 5828
• 5700

Resistance

• 6000
• 6025
• 6090

The euro is slightly lower on Tuesday after rallying 1.2% over the past two trading sessions. In the North American session, EUR/USD is currently trading at 1.0363, down 0.25% on the day.

Eurozone, German CPI rises in December

Eurozone inflation accelerated for a third successive month, climbing to 2.4% y/y in December, up from 2.2% in November and in line with the market estimate. Energy prices increased for the first time since July and services inflation rose to 4% from 3.9%, double the European Central Bank’s target of 2%. The core rate remained unchanged at 2.7%, matching the market estimate.

In Germany, the eurozone’s largest economy, inflation jumped in December and was higher than expected. Annual inflation hit 2.6%, up from 2.2% in November and above the market estimate of 2.4%. Monthly, CPI rose to 0.4%, up sharply from -0.2% in November and above the market estimate of 0.3%. With inflation rising and economic activity struggling, there is a significant possibility of stagflation, which is a combination of slow economic growth and high inflation.

How will the ECB react to the latest inflation data? The ECB lowered rates by 25 basis points in December and is likely to continue trimming rates in early 2025. The deposit interest rate of 3% is still restrictive for the weak eurozone economy. The ECB could cut rates by 25-basis points at the next meeting on January 30.

The US economy is in good shape, buoyed by a robust services sector. The S&P Global Services PMI eased in December to 56.8, down from 58.5 in November. This was followed by the ISM Services PMI rose to 54.1 in December, up from 52.1 and above the market estimate of 53.3. This points to solid expansion in the services industry.

EUR/USD Technical

• EUR/USD is testing resistance at 1.0374. Above, there is resistance at 1.0453
• There is support at 1.0312 and 1.0233

EURCHF, H4

EURCHF is rising and breaching above the upper Bollinger Band.

The RSI oscillator is in the oversold zone, giving a Counter-trend strategy set up on the chart, with a good opportunity to short the asset!

Consider a short trade on EURCHF on a consolidation below 0.9420 with the target at 0.9400 and 0.9360.

Highlights

• At the Central Economic Work Conference, authorities said all the right things, pledging to deploy fiscal and monetary stimulus to boost domestic demand and create the conditions to develop a consumer-driven economy.
• However, the strategy behind fiscal stimulus thus far bears an eerie resemblance to Japan’s in the 1990s after the bursting of the asset bubble.
• Structurally stronger consumer demand in China would help rebalance the growth model and take pressure off authorities to provide repeated rounds of stimulus.
• To the extent Chinese authorities fall short, it would entrench excess capacity that would be a disinflationary force globally, while also weighing on sales and margins of multinationals operating in China. However, tit-for-tat escalation of tariffs and export restrictions risks creating a whipsaw effect on global prices.

China’s economy continues to contend with the ramifications of a housing market meltdown, decades of investment-driven growth, and a trade war with the U.S. that is set to re-accelerate. Faced with these headwinds, policymakers have recommitted to monetary and fiscal stimulus to boost domestic demand. This is critical for durable growth, but how the money is spent is almost as important as how much. To date, the strategies deployed by policymakers harken back to those in post-asset bubble Japan rather than the reforms and spending that have been called for. An extension of the approach employed thus far risks proving inadequate to materially lift China’s soft inflation or help reset the country on a sustainable growth trajectory.

For North American firms and households, the implications are two-fold; (1) the absence of domestic pricing power will likely imply margin compression and reduced profitability for foreign firms operating in China, and (2) the course of the trade war will determine if, and when, the global disinflationary force from China’s excess supply manifests.

The Base Case

We expect China’s growth to clock in at 4.8% in 2024, in line with the 5%-ish target set out by policymakers. Next year, authorities are likely to set a growth target of around 5%, along with an expansion in the fiscal deficit1. However, risks are tilted to the downside and our forecast is for a 4.7% expansion, a virtual repeat of this year’s performance, as the trade war with the U.S. gains steam. There is ample uncertainty around this forecast as the scale and scope of tariffs, along with the size of the policy response from China’s authorities, remains unknown.

Consumer spending has expanded well below its pre-pandemic pace (Chart 1). October’s retail spending figures were a welcome uptick as the latest round of stimulus measures (in part the cash-for-clunkers program for household appliances) helped lift spending, but November saw a give-back of some of the gains. Ample capacity remains, and with home prices continuing to correct (albeit at a slower pace2), consumer confidence is likely to be locked in the doldrums, resulting in a protracted recovery.

A soft outlook for household demand is the driving force behind our expectation for a near-absence of inflation in 2025. Weakness in indicators of consumers’ assessment of prospects add conviction to this view. Loan demand remains tepid, with new loan growth failing to gain traction in the months after interest rate cuts. This signals a preference towards paying down balances and rebuilding balance sheets (Chart 2). The upshot is that incremental increases in incomes would be diverted to balance sheet repair rather than capacity absorbing net-new demand.

Thus far, price growth has continued to cool with both economy-wide measures (the GDP deflator) and consumer prices in, or near, deflationary territory. The weak pricing environment is bleeding through to inflation expectations, measures of which have been on a downward trajectory for months (Chart 3).

The risk is that this spirals into a deflationary trap, where falling prices create a self-reinforcing loop of delayed demand, increased savings, and further economic weakness. This would add further global disinflationary pressure, while also weighing on foreign firms’ investment returns in China.

The Trade War is About to Flare Up

The trade war between the U.S. and China never went away when the Biden administration took over in 2021. While rhetoric cooled, and U.S. allies were no longer overtly threatened with tariffs, restrictions on China’s access to critical U.S. components were ramped up and tariffs were kept in place.

We have already gotten a hint of how China will respond to additional tariffs. Using a set of new laws and regulations, authorities are now willing and able to target individual firms and limit supplies of key products to other countries. Authorities have used these powers to target companies with ties to the U.S. national security establishment3 and limit the availability of three critical minerals – germanium, gallium and antimony – driving up their prices. Moreover, straightforward tariffs on U.S. agricultural exports are now more feasible than in the past as China has diversified its import sources away from the U.S. in recent years. This allows for retaliatory tariffs while limiting damage to domestic consumers.

However, these present the worst-case scenario for the trade war. Chinese authorities will likely look to strike a delicate balance between trade retaliation to stand up for their interests and alienating foreign firms through actions perceived as unfriendly to businesses. The tradeoff is important as avoiding disorderly capital flight remains top-of-mind amid a tapering-off of foreign direct investment flows into the country (Chart 4) and the prospect of further yuan devaluation to combat tariff hikes4.

Worrisome Policy Parallels with Japan’s Fiscal Strategy from the 1990s

More fiscal and monetary stimulus is on the way5, but how it is implemented matters greatly for the economy. For this reason, Japan’s experience after the bursting of the asset bubble in the late 1980s is an interesting case study. The focus below is on the ineffectiveness of Japan’s fiscal policy, even though a multitude of factors weighed on growth over the following decade (including a liquidity trap, a credit crunch, and the Asian Financial crisis6).

First, and foremost, Japan’s policymakers remained committed to fiscal discipline7 at a time that growth slowed rapidly. Initial budgets were often not expansionary – and sometimes outright contractionary – only further loosening when the hoped-for growth failed to materialize8. This stop-start dynamic was found to increase uncertainty, undermining the hoped-for growth lift9. This bears an eerie similarity to China’s recent strategy of targeting a 3% deficit, and then making up ground later in the year by allowing it to increase (as in 2023), or through the ad-hoc issuance of special purpose bonds10.

Importantly, this incremental strategy looks set to extend into next year. The IMF’s projection for the Augmented Cyclically Adjusted Primary Balance (a measure of the deficit that includes borrowing from local government funds and strips out the effects of automatic stabilizers) showed that a remarkable degree of restraint was expected around mid-year when the Article IV consultation was done (Chart 5). Even with the new announcements at the Central Economic Work Conference, the official deficit target for 2025 is rumored to be roughly 4%, only moderately higher than the 3% target this year11. It was only later in the month that rumors of a 3 trillion yuan (2.4% of 2023 GDP) special bond issuance to fund consumption support, infrastructure, and bank recapitalization emerged12.

Secondly, Japan relied on local governments to deliver public investment projects, but cash-strapped and highly indebted localities chronically underspent, opting to not to invest in low-return public projects to deliver central government spending promises13. This mirrors the current situation in China where local level governments are operating under large debt burdens with limited revenues. Faced with fewer projects that can meet investment criteria14, and wary to add more debt amid falling land sales, they have not been fully using up their budgeted allotment of special purpose bonds.

The problem is that public investment forms an important avenue for the kind of “Real Water” measures that lift GDP. So, despite years of investment-driven growth eroding the marginal returns on new initiatives15,16, it still forms an important part of the policy prescription. For China, an opportunity exists to use the funds to facilitate the transition to a consumer-driven economy through investments to expand the social safety net.

Lastly, Japan’s announced stimulus was often not allocated to GDP boosting ventures (“Real Water” initiatives). Asset reshuffles to restore balance sheets were often lumped in with headline stimulus figures that, while serving a purpose, were not effective in creating net-new domestic demand and absorbing excess capacity. China faces a similar situation. For instance, the 10 trillion-yuan ($1.4 trillion) announcement for local government debt swaps is an important (and expensive) measure to bring relief to local level balance sheets17, and likely a necessary condition to get increased compliance with the aforementioned additional borrowing, but not stimulating net-new demand on its own.

The Good News

Policymakers continue to say all the right things. Monetary policy is going to be “moderately loose”, and authorities stressed the importance of spurring consumer demand at December’s Central Economic Work Conference (CEWC)18. An expansion of the evidently effective cash-for-clunkers program for consumer goods is in the cards. Rumors of a large special bond issuance (2.4% of 2023 GDP) to bankroll the scheme and fund strategic investments have also emerged in the past weeks19. Optimistically, reporting from the CEWC, contained language on solidifying the social safety net20. The effective expansion of social supports would help create room for the persistently high household savings rate to fall, a necessary condition for the sustainable rotation to a consumption led growth model.

All the focus on the consumer will be needed as the effectiveness of additional monetary stimulus is highly uncertain. Sinking credit demand suggests that looser monetary policy may have a small impact on growth as, even at lower rates, borrowers don’t see much upside to increasing leverage. That said, supporting asset prices to prevent a steep correction21 (likely in the hopes of propping up consumer sentiment and stimulating a wealth effect) is part of the stimulus playbook.

To avoid a credit crunch, capital buffers at major banks were proactively increased in September22, helping absorb some of the ongoing margin compression from a cut to existing mortgage rates and lower long-term rates. As major banks are relied upon to implement credit expansions23, preemptively shoring up balance sheets should help ease the burden of lending in a more challenging environment.

Lastly, at its Third Plenum in the summer, authorities began reforms to add more revenue levers for local governments. In particular, the gradual move to “pass collection power to local government”24 of excise taxes is an important transition to provide local government an alternative to land sales as a revenue source.

Bottom Line

At the CEWC, authorities said all the right things, pledging to deploy fiscal and monetary stimulus to boost domestic demand and create the conditions to develop a consumer driven economy. That’s all well and good, but now we need to see it in practice. The rumored expansion of the deficit to 4%, along with a 5% growth target for 2025 suggest that the piecemeal approach to policy will continue, with comprehensive reforms to bolster the social safety net and wean off the investment driven growth model being kicked further down the road.

Absent a coordinated fiscal and monetary impulse, domestic demand is likely to be insufficient to absorb the economy’s productive capacity. This means ongoing downward pressure on prices. This also implies exports will continue to be a key source of real growth, raising the risk of drawing the ire of trade partners that could be inundated with relatively inexpensive products. A tail risk is that severe trade retaliation from the U.S. and others results in a whipsaw effect on prices as tit-for-tat escalations results in China implementing severe export restrictions on critical components.

For the global outlook the implications are twofold. First, with or without new U.S. tariffs, the absence of a large stimulus effort means demand for commodity inputs is unlikely to surge. For global consumers of commodities, this provides an element of stability to the price outlook and thus global producer prices.  Moreover, a steep devaluation of the yuan could make Chinese exports relatively cheaper, adding another disinflationary force on input prices.

Secondly, for North American firms with substantial investments in China, the downbeat domestic situation could weigh on sales activity and investment returns. For some perspective, Canadian multinational enterprises reported sales equivalent to almost 0.7% of GDP in China in 2023. U.S. data are slightly more lagged, but majority owned affiliates reported sales equivalent to 1.9% of GDP in 2022. Moreover, with trade tensions escalating, uncertainty about the prospective returns on hundreds of billions of dollars of assets in China increases.

So, now we wait. A concerted and coordinated approach to stimulus could lift China’s prospects for 2025 and beyond, facilitating the rotation to a consumer driven economy. Much like in the U.S., the decisions by key policymakers in the coming months could have widespread ramifications.

End Notes

1. Reuters (Dec. 17, 2024) “Exclusive: China Plans Record Budget Deficit of 4% of GDP in 2025, Say Sources” https://www.reuters.com/markets/asia/china-plans-record-budget-deficit-4-gdp-2025-say-sources-2024-12-17/
2. Reuters (Dec. 16, 2024) “China Sees Slowest Home Price Decline in 17 Months Amid Signs of Stabilisation” https://www.reuters.com/markets/asia/china-new-home-prices-fall-slowest-pace-17-months-nov-2024-12-16/
3. Bergen, M., M. Hawkins, G. Volpicelli (Dec. 9, 2024) “China is Cutting Off Drone Supplies Critical to Ukraine War Effort” Bloomberg News, https://www.bloomberg.com/news/articles/2024-12-09/china-is-cutting-off-drone-supplies-critical-to-ukraine-war-effort
4. Reuters (Dec. 11, 2024) “Exclusive: Chinese Authorities Are Considering a Weaker Yuan as Trump Trade Risk Looms” https://www.reuters.com/markets/currencies/chinese-authorities-are-considering-weaker-yuan-trump-trade-risks-loom-sources-2024-12-11/
5. Xinhua (Dec. 12, 2024) “China Holds Central Economic Work Conference to Make Plans for 2025”, State Council of The People’s Republic of China, https://english.www.gov.cn/news/202412/12/content_WS675ae633c6d0868f4e8ede69.html,
   Reuters (Dec. 24, 2024) “Exclusive: China Plans Record $411 Billion Special Treasury Bond Issuance Next Year” Reuters News: https://www.reuters.com/world/china/china-plans-411-bln-special-treasury-bond-issuance-next-year-sources-say-2024-12-24/
6. See. Kuttner, K., A. Posen, (2001) “The Great Recession: Lessons for Macroeconomic Policy from Japan” Brookings Papers on Economic Activity, Vol. 2001, No.2 (2001), pp. 93-160; Bayoumi., T. (2000) “The Morning After: Explaining the Slowdown in Japanese Growth” Post-Bubble Blues: How Japan Responded to Asset Price Collapse, Ch. 2, IMF; Ramaswamy, R., C. Rendu (2000) “Identifying the Shocks: Japan’s Economic Performance in the 1990s” Post-Bubble Blues: How Japan Responded to Asset Price Collapse, Ch. 3., IMF; Wilson, B.A. (2008) “Japanese Fiscal Policy: A Bridge to Nowhere” FOMC https://www.semanticscholar.org/paper/8.-Japanese-Fiscal-Policy%3A-A-Bridge-to-Nowhere-Wilson/913f5677e0125ce0fb8c6931271f984eb59e72b0
7. Mulhleisen, M., (2000) “Too Much of a Good Thing? The Effectiveness of Fiscal Stimulus” Post-Bubble Blues: How Japan Responded to Asset Price Collapse, Ch. 6, IMF
8. Mulhleisen, M., (2000) “Too Much of a Good Thing? The Effectiveness of Fiscal Stimulus” Post-Bubble Blues: How Japan Responded to Asset Price Collapse, Ch. 6, IMF
9. Wilson, B.A., (Dec. 5, 2000) “Japanese Fiscal Policy – A Bridge to Nowhere” FOMC
10. Posen, A. (1998) “Fiscal Policy Works When It Is Tried” Restoring Japan’s Economic Growth, Ch. 2, Institute for International Economics
11. Reuters (Dec. 15, 2023) “China to Run Budget Gap of 3% of GDP in 2024, Issue Special Debt” https://www.reuters.com/world/china/china-run-budget-gap-3-gdp-2024-issue-special-debt-sources-2023-12-15/
12. Reuters (Dec. 24, 2024) “Exclusive: China Plans Record $411 Billion Special Treasury Bond Issuance Next Year” Reuters News: https://www.reuters.com/world/china/china-plans-411-bln-special-treasury-bond-issuance-next-year-sources-say-2024-12-24/
13. Ishii, H., E. Wada, (1998) “Local Government Spending: Solving the Mystery of Japanese Fiscal Packages” Peterson Institute for International Economics, Working Paper 98-5, https://www.piie.com/publications/working-papers/local-government-spending-solving-mystery-japanese-fiscal-packages
14. Huang, T., (2024) “Lessons from China’s Fiscal Policy During the COVID-19 Pandemic” Peterson Institute for International Economics.
15. Bloomberg News (Jul. 13, 2023) “Next China: Road to Nowhere” https://www.bloomberg.com/news/newsletters/2023-07-14/roads-to-nowhere-highlight-xi-s-stimulus-conundrum-next-china
16. Ishii, H., E. Wada, (1998) “Local Government Spending: Solving the Mystery of Japanese Fiscal Packages” Peterson Institute for International Economics, Working Paper 98-5, https://www.piie.com/publications/working-papers/local-government-spending-solving-mystery-japanese-fiscal-packages
17. Bloomberg News (Nov. 8, 2024) “China Unveils $1.4 Trillion Debt Swap, Saves Stimulus for Trump” https://www.bloomberg.com/news/articles/2024-11-08/china-unveils-839-billion-debt-swap-to-rescue-local-governments?srnd=homepage-asia
18. Xinhua (Dec. 12, 2024) “China Holds Central Economic Work Conference to Make Plans for 2025”, The State Council of The People’s Republic of China,  https://english.www.gov.cn/news/202412/12/content_WS675ae633c6d0868f4e8ede69.html
19. Reuters (Dec. 24, 2024) “Exclusive: China Plans Record $411 Billion Special Treasury Bond Issuance Next Year” https://www.reuters.com/world/china/china-plans-411-bln-special-treasury-bond-issuance-next-year-sources-say-2024-12-24/
20. Xinhua News Agency (Dec. 12, 2024) The Central Economic Work Conference was held in Beijing, and Xi Jinping delivered an important speech-Xinhuanet
21. Reuters (Oct. 18, 2024) “China Rolls Out $112 Bln Funding Schemes to Bolster Stock Market” https://www.reuters.com/world/china/china-kicks-off-112-billion-funding-schemes-support-stock-market-2024-10-18/#:~:text=BEIJING%2FSHANGHAI%2C%20Oct%2018%20(,newly%2Dcreated%20monetary%20policy%20tools
22. Bloomberg News (Sep. 23, 2024) “China to Add Capital at Big Banks for First Time in a Decade”  https://www.bloomberg.com/news/articles/2024-09-24/china-to-boost-capital-at-mega-banks-for-first-time-in-a-decade
23. Mak, R. (Nov. 11, 2024) “China Hands Banks Poor Stimulus Consolation Prize” Reuters, https://www.reuters.com/breakingviews/china-hands-banks-poor-stimulus-consolation-prize-2024-11-11/
24. Xinhua (Jul. 26, 2024) “China to Accelerate Building a Fiscal System Compatible with Chinese Modernization” The State Council of The People’s Republic of China https://english.www.gov.cn/news/202407/26/content_WS66a389eec6d0868f4e8e97b2.html

The ISM Services index rose 2.0 points to 54.1 in December, slightly ahead of the 53.5 consensus was expecting. However, only nine industries out of eighteen reported growth, five fewer than in October and November.

Business activity recovered last month, rising 4.5 points to 58.2, more than offsetting last month's pullback. Conversely, new order growth firmed only slightly (54.2 vs 53.7 last month) and was unable to match October's 57.4 reading.

The employment sub-index was virtually unchanged (51.4, -0.1 points) suggesting a modest expansion of payrolls. December was the third consecutive month of payrolls growth and the sixth of the year.

The prices paid sub-component jumped sharply (+6.2 points to 64.4) indicating that prices rose at their fastest pace since February of 2023.

Key Implications

A bit of a mixed bag to end the year from the ISM services index. The top line figure showed a healthy services sector with business activity posting a solid expansion and payrolls continuing to expand. However, the breadth of the expansion narrowed as only half of the industries reported growth for the month. It will also be worth keeping an eye on whether the jump in the prices paid component is a temporary blip like last January or the start of another march higher on input costs.

This report was better than expected, but heading into 2025 uncertainty is the name of the game. The prospect of port disruptions, new tariffs and possible changes to tax policy are all clouding the outlook. For policymakers, monitoring whether any of these factors are leading to sustained inflationary cost pressures will be top of mind.