Market Brief: China Stimulus Hopes Overshadow Geopolitical Fears 

Risk-sensitive currencies are advancing against their safe-haven counterparts after Chinese authorities explicitly signalled more stimulus to come in the year ahead. Currencies like the Australian and Canadian dollars—along with the euro and British pound—are up against the dollar and Japanese yen as investors price in a stronger global growth impulse, defying geopolitical concerns unleashed by the weekend’s toppling of Bashar Assad’s regime in Syria.

Chinese leaders certainly seem to be pulling out the stops. In an official statement provided ahead of this week’s Central Economic Work Conference, the Politburo said it would push monetary policy in a “moderately loose” direction in 2025, promising to “stabilize property and stock markets”. Onshore markets are up, the renminbi is inching higher, and commodity prices are climbing in global markets.

But the government still seems intent on avoiding a rebalancing toward household consumption. The language in the statement is indicative of efforts to lower borrowing costs, ease strains on local governments, and support property markets - steps that should prove helpful in avoiding a steep downturn, but which fall short of the sort of labour market and social safety net reforms that might help stabilise the economy by boosting the consumption share of gross domestic product. Until policymakers show more willingness to support the household sector, participants might be wise to maintain a market stance consistent with a gradual “Japanification” of China*.

Friday’s US non-farm payrolls report showed hiring rebounding in November as the effects of strikes and hurricanes dissipated. 227,000 positions were added in November, slightly above the 220,000 median consensus forecast, and job growth in the prior two months was revised up by 56,000, lifting the three-month average pace of job creation to 173,000 from 123,000 previously. Average hourly earnings rose 0.4 percent from the prior month.

But beneath the surface, there were warning signs for job markets. The labour force participation rate unexpectedly fell to 62.5 from 62.6 in October, and the unemployment rate, while still historically low, climbed to 4.246 percent, edging closer to the 4.253 percent level hit in July.

The Fed is seen responding cautiously. Investors are now assigning better than 85 percent odds to a quarter-point rate cut at next week’s meeting—up from 65 percent prior to the release.

Inflation numbers released on Wednesday and Thursday could, of course, push the odds in a different direction. If consumer price growth exceeds 0.3 percent on a month-over-month basis or producer prices come in hotter than anticipated, markets might reappraise the direction of underlying disinflationary processes, and move to price in a pause before January.

We don’t think that will happen, but we suspect that policymakers will raise the expected path for the Fed Funds rate when they update their summary of economic projections. Growth, inflation, and job market conditions have all held up better than had been expected in September, and if 2016’s post-election “dot plot” can be considered to provide any precedent, the median official will brace for an increase in fiscal spending, labour supply constraints, and prices in the years ahead, pushing "neutral rate" estimates higher.

After Friday’s disappointing Canadian jobs report, markets are now confident the Bank of Canada will deliver a second consecutive 50 basis-point cut on Wednesday morning. Glimmerings of a potential consumer rebound are evident in housing markets and retail sales numbers, but data in recent weeks has shown growth weakening and unemployment pushing higher—reducing the likelihood of an inflationary overheat—and Donald Trump’s tariff threats will likely to add to the headwinds facing investment and consumer spending. We think Tiff Macklem and colleagues will err on the side of caution, building a policy buffer against further weakness.

Taken in combination with an expected 25 basis-point move from the Fed in the following week, this could push the differential between US and Canadian policy rates to the widest since … October. History shows** that it isn’t the policy differential that drives the exchange rate over long time horizons, but it is the gap between unemployment rates that tends to offer the strongest guidance on future movements in the loonie.

Across the pond, the European Central Bank is highly likely to cut rates by a quarter point in Thursday’s decision, but it is what officials say about the path ahead that could prove more impactful for markets. In a series of recent appearances, members of the Bank’s rate-setting council were fairly unanimous in expressing support for a December cut, yet seemed divided on the need to move aggressively in the first half of next year. The benchmark interest rate is currently set in restrictive territory at 3.4 percent—about a percentage point above headline inflation—and growth risks are clearly tilted to the downside, with incoming president Trump’s tariff threats likely to exacerbate the uncertainty facing European businesses and consumers. Investors accordingly expect rate cuts at back-to-back meetings through June. But wage increases have accelerated, and declines in inflation mean real incomes are rising, suggesting that economic slack could narrow in the months ahead.

*The parallels are far from exact—history rhymes, it doesn't repeat—but the impact on global markets could look surprisingly similar.

**Apologies for the horrific dual-axis chart, I simply couldn't think of a better way to show the relationships in play. If you think of something better, please shoot me a note.

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