Attacks by Houthi rebels in the Red Sea, have caused mainline operators to reroute ships around the Cape of Good Hope. The Shanghai containerized freight index had jumped 40.2% in the week to December 29th, the highest since October 2022. Goods prices should start to climb. The Fed may be unable to rely on a prolonged bout of durables deflation to return inflation to target. Chinese iron ore prices also rose to $145 per tonne yesterday, up 22.6% over the past year.
The underlying rate of economic growth in the US appears to be firming. Rather than getting tighter, monetary policy may now have become too easy. If underlying or trend real US economic growth is around 2.5%, and if core PCE inflation also settles around 2.5% (slightly higher than the Fed’s target), then a 5% yield on the 10-year Treasury note is well within reach and may even be a floor. With a positive term premium, it could be even higher.
A positive term premium is to be expected, given the current backdrop (very loose fiscal policy, in conjunction with climate change and geopolitical risks). For now, the US is running a ‘guns & butter’ economy. The potential for further supply shocks is only growing. The Treasury market has not fully discounted these risks. A wider Middle East conflict is certainly not priced in, despite recent signs of escalation.
The Taiwanese 2024 Presidential election is just 10 days away. A DPP win could increase China’s hawkishness over Taiwan. It is hard to envisage a thawing of US-China relations. Chinese exports of advanced machine tools to Russia, vital to Moscow’s military industries, have surged since the invasion of Ukraine. Putin has vowed to intensify attacks, as Moscow prepares for a long war. The order backlog at major defence companies continues to grow: “Ten of the West’s largest defense companies alone are currently sitting on order books worth over $730 billion, up around 57% from the end of 2017”.
