Geoeconomics Bi-Weekly: A Soft Landing? Interest Rates Held Steady as the Year Ends

Happy holidays everyone! This is our last newsletter for 2023, and we will be back in January. Several central banks also had their last meetings of the year this week, ending 2023 with positive signs in the global fight to tame inflation. 

Macroeconomic Update 

The central banks of Australia, Canada, England, Europe, and the United States all held interest rates steady in their final meetings of the year, sparking optimism that interest rate hikes are over with. U.S. Federal Reserve officials even indicated that they could cut interest rates as many as three times in 2024, sending the Dow Jones to an all-time high. 

The optimism in the United States stems from the economic resilience displayed recently, which prompted Treasury Secretary Janet Yellen to suggest that the country is on a path towards a “soft-landing” of curbing inflation without triggering an economic slowdown. U.S. unemployment in November fell to 3.7%, its lowest level since July, average hourly earnings grew by 0.4%, and the number of new job openings pleasantly surprised analysts.  

Still, inflation persists above the Fed’s 2% target, and the central bank remains attentive to inflation risks. The Personal Consumption Index (PCE), the Fed’s preferred inflation metric, fell to an annualized rate of 3% in October, while core PCE inflation, which excludes volatile energy and food prices and is therefore seen as a better long-term indicator, remains higher at an annualized rate of 3.5%. 

Outside the United States, while several other central banks held interest rates steady, each is at a different point in its effort to tame inflation. Eurozone annualized inflation fell to 2.4% in November, creating pressure to cut interest rates as soon as March. In contrast, U.K. annualized inflation in October was 4.7%, leading Bank of England governor Andrew Bailey to minimize expectations of impending rate cuts.  

Stories of the Week 

1. Global trade comes under additional threat as merchant ships in Middle East are attacked by Houthi’s in Yemen: Several merchant ships in the Red Sea were attacked in the past two weeks by the Houthi’s, an Iranian-backed militia in Yemen, representing both a risk of escalation of the ongoing Israel-Hamas War and a threat to global trade. The Red Sea links the Indian Ocean to the Suez Canal, which carries approximately 12% of annual global trade, including 7-10% of the world’s oil. The attacks threaten to undermine seaborne trade through the Middle East—insurance premiums have risen for ships traversing the region and some are electing to voyage around the horn of Africa instead, adding weeks to their journey. The Houthi’s have claimed they will attack all ships heading to Israel, though several vessels without clear ties to Israel have come under fire. Attacks have consisted of drone and missile strikes, as well as several hijackings.  

2. China faces credit downgrade amid modest export momentum: As China struggles with a property sector insolvency crisis and sluggish economic growth, credit ratings agency Moody’s downgraded China’s government credit rating outlook from stable to negative. At the same time, Chinese exports—a key driver of China’s economic activity during the pandemic—increased in November for the first time in six months thanks to lower export prices and low domestic inflation. Exports are still down between 5-6% for the year given the high-interest-rates, high-inflation environment in today’s global economy, though economists expect a better performance next year. Overall, Moody’s did not change the rating for China’s national long-term debt, as it is confident the Chinese government has the resources to “manage the transition in an orderly fashion.” 

3. Secretary Yellen visits Mexico City as Chinese investment in the U.S.’ neighbor booms: Mexico has always been closely tied with the United States, though the current geopolitical climate is magnifying the relationship’s importance. Mexico has received a significant increase in foreign investment, including from China, as companies seek to diversify their supply chains due to its strategic location on the U.S. border—a trend known as “nearshoring.” Highlighting Mexico’s increasingly important position, Treasury Secretary Janet Yellen traveled to Mexico City last week to deepen economic ties and warn of the risks of Chinese investment. While Mexico is now the United States’ largest trading partner, surpassing China earlier this year, China has doubled its investments in Mexico since 2018. Many products bound for the United States may still be made in Chinese-owned factories or require key inputs from China. The United States and Mexico ultimately agreed to monitor foreign investments and share information about their screening processes. 

4. The United States awards first CHIPS grant as it seeks to secure supply of vital semiconductors: The Biden Administration announced on Monday that BAE Systems, a U.K-headquartered defense contractor, will receive the first grant from the CHIPS and Science Act. The award continues a trend of trans-Atlantic cooperation in semiconductors, as the United States and its European allies work to secure supplies of the incredibly complex yet vital technology. BAE Systems will receive approximately $35 million to quadruple production of a semiconductor used in fighter jets, satellites, and other defense systems in its New Hampshire plant. Following the announcement, Commerce Secretary Gina Raimondo stated that she expects the CHIPS Office will make around a dozen additional grants within the next year, some of which could exceed $1 billion. The CHIPS Act appropriates over $52 billion to boost domestic semiconductor manufacturing and research. 

5. Xi Jinping visits Vietnam as the Southeast Asian nation balances relationships with China and the United States: Like Indonesia which we covered last week, Vietnam is emerging as a key nation courted by both the United States and China as the world’s two largest economies search for partners in their growing economic competition. With a large, young, and increasingly educated workforce, Vietnam has developed into a highly desirable investment destination as companies seek to diversify their supply chains. Vietnam also boasts the 2nd largest deposits of rare earth metals in the world, which are key inputs for technologies ranging from smartphones to electric vehicles (EVs). Demonstrating Vietnam’s increasingly important role, Xi Jinping visited Hanoi this week in a rare trip abroad as the two countries pledged to build a “shared future.” Xi’s visit comes three months after President Biden visited Vietnam to announce a “comprehensive strategic partnership” between the two nations, Vietnam’s highest designation for foreign partners. Vietnam, a fiercely independent nation, appears to be utilizing its strategic importance to its benefit, courting U.S. investment while maintaining good ties with its neighbor to the north. 

What we’re watching 

• January 1 – EVs containing batteries with Chinese-made components or other ties to China will no longer be eligible for the full subsidies from the Inflation Reduction Act. This updated rule announced earlier in December aims to cut China out of the U.S. EV supply chain while denying China’s booming EV industry additional revenue. 

• January 13 – Citizens of Taiwan head to the polls to elect a new president, as incumbent Tsai Ing-Wen is serving in her second and final term. The current front-runner is Tsai’s vice-president, Lai Ching-te, who’s policy towards China is to maintain the status quo and not declare independence. Still, China has framed the election as “a choice between war and peace.” The status of Taiwan, which produces 90% of the world’s most advanced semiconductors, remains one of the biggest flashpoints in U.S.-China relations.  

• January 19 – U.S. government funding for the Departments of Transportation, Housing and Urban Development, Energy, and Veterans Affairs expires following a stop-gap funding bill signed in November. Other government agencies are currently funded through February 2.