Good News in Disguise

The macro point

Caution, when looking in detail, China is not yet out of the woods.

The return of inflation is mainly linked to a rise in food prices, which can reverse overnight. Moreover, producer prices are still negative, at -1.9% year-on-year. This reflects overcapacity in the industry, which has eroded net margins, even in innovative sectors like semiconductors. Historically, fluctuations in the producer price index, both upward and downward, have invariably resulted in expansion or contraction of company margins. The current situation is no exception. Profit margins, which peaked at 6.5% in 2021, are now at the low point of 2015.

Not all sectors have suffered equally from the deflation that coincided with weak domestic demand. Consumer services (notably technology platforms like Alibaba) have seen their margins improve after the tightening of regulations in 2021-22, and now show record profits. The infrastructure sector is also doing well overall. But profits in the materials and energy sectors continue to decline, and the priority sectors of industrial policy — capital goods and technology equipment — have seen their profitability fall sharply in 2024 and 2025. This is worrying.

If the situation does not improve, the risk is that the Chinese economy will plunge back into deflation during the year. This would be bad news for Europe as it is already facing relentless pressure from the Americans and its growth remains sluggish overall (except for Germany, which, thanks to its stimulus plan of February 2025, could see GDP growth of 1.5% this year).

On the American side, it was not the statistics — few last week — that aroused interest. It was the battle between Donald Trump and Jerome Powell that resumed with a vengeance and raises investors' fears of a challenge to the independence of the US Federal Reserve (Fed). We doubt that this risk is credible. In the past, almost all Fed presidents have faced an overly intrusive executive. The enmity between Trump and Powell is well known. But there was worse. In 1965, President Lyndon Johnson (Democrat) summoned Fed President William McChesney Martin to his ranch in Texas. The discussion was reportedly heated, to the point where Johnson pushed Martin against a wall, exclaiming: 'Martin, my boys are dying in Vietnam, and you won't print the money I need.'*

The debate over Fed independence can create volatility, even be a factor in the short-term fall of the dollar. However, we doubt that it will have a real effect on the rate trajectory. We maintain our forecast of two rate cuts for a total of 50 basis points in the first quarter. This should be sufficient, with the budgetary measures planned before the mid-term elections, to trigger an acceleration of US growth in the second half.

* At the time, the events were reported by the New York Times

Technical point

In the currency market, the US dollar is still penalized by the "debasement trade." Investors, particularly institutional ones, are reducing their exposure to USD assets due to the surge in US public debt, probably unfounded fears about inflation, and the political risk linked to Trump’s interventions. This benefits the euro, which remains in a long-term bullish channel with a first target at 1.20. It also greatly advantages gold, which in this context regains its status as a safe haven.

Meanwhile, the Chinese yuan reached a high since May 2023 against the US dollar last week. The currency also appreciated slightly against the euro. This is good news, although there is still a long way to go to achieve an exchange rate more representative of China’s economic fundamentals. Omitting the effect of inflation, the yuan is at its lowest level in 15 years against the basket of currencies of its main trading partners. This is, of course, a subject of friction with the Americans.

Announcements to follow

Geopolitics can at any moment return to the forefront. Meanwhile, traders will closely follow this week’s meeting of the Bank of Canada (BoC). Barring any surprises, it should keep its rates unchanged at 2.25%. Attention, the easing cycle is not over. It is rare for central banks to move their rates at the beginning of the year. Why? They simply wait to have more statistics on the economic direction for the year before deciding. Another 25 basis point cut is credible in March.

Finally, several secondary statistics are expected, such as the first estimate of the PMIs on both sides of the Atlantic and the UK inflation in December (2^nd estimate). No impact on currencies is expected.

The information presented in this publication is communicated to you purely for informational purposes and does not constitute investment advice, an offer to sell, or a solicitation to buy, and should not, under any circumstances, be taken as an incentive to engage in any investment.