The ECB will not change the sequencing of rate hikes to follow the end of asset purchases, and the Governing Council has repeatedly pushed back on the likelihood of 2022 rate hikes. That is probably even more so the case given the likely dampening effect of the surging Omicron variant on travel, hospitality, and economic activity at least in the very near term. But importantly, sources have also stressed that this push back does not extend to 2023, and there are no “guarantees” of no hikes beyond 2022. Frankly speaking, even the late 2022 pushback, while seen as extremely unlikely, is not 100% ironclad.

This means the ECB will not commit to asset purchases beyond 2022, and will, as we stated in our November 22 report, very likely seek flexibility to start the year higher, but gradually unwind the Asset Purchase Program through the course of the year. Flexibility of course can go both ways, resulting in higher as well as lower purchases, but the maneuverability that is sought is to end QE by the end of 2022 if all pans out as expected.

On the credit front, the CEWC pledged to stabilize credit growth, keeping total social financing growth broadly in line with nominal GDP growth.

That means next year’s credit target will be basically the same as this year, or slightly increased. That too will be front loaded — new loans are expected to reach about 20 trillion yuan in 2022, with the first quarter likely to be close to 8 trillion yuan, up about 300 billion yuan from 7.7 trillion over the same period last year.

Last Minute Thoughts Heading into the FOMC Meeting

Policy must adjust accordingly, but what exactly does that mean? At minimum, the Fed’s pivot will be immediately operationalized in an acceleration of tapering. The Fed will also raise the expected path of policy rates such that participants expect two rate hikes in 2022 with a risk of more. The Fed will adjust language in the FOMC statement to remove “transitory” and may also signal the economy has made “further progress towards” or is “on track to meet” the Fed’s goals.

Monetary Policy
On the monetary front, the stimulus will likely come in two phases. From when the most recent Reserve Requirement Ratio cut takes effect on December 15 to the Spring Festival on February 1, there will be an injection of more liquidity into the markets through the ramping up of re-lending to banks, including through a recently introduced decarbonization supportive tool. Another RRR cut will probably come then in February, although some officials think an interest rate cut may be less likely.
For perspective on magnitude and the room for stimulus, the CEWC meeting set the CPI target for 2022 at 3.0%, the same as for 2021, but predicted inflation would rise in a more modest way, from 0.9% in 2021 to 2.2% in 2022. And so, officials believe inflation will pose no major constraints on monetary policy.
Credit Policy
On the credit front, the CEWC pledged to stabilize credit growth, keeping total social financing growth broadly in line with nominal GDP growth.
That means next year’s credit target will be basically the same as this year, or slightly increased. That too will be front loaded — new loans are expected to reach about 20 trillion yuan in 2022, with the first quarter likely to be close to 8 trillion yuan, up about 300 billion yuan from 7.7 trillion over the same period last year.

The likely data highlight of the week comes Wednesday in the form of the retail sales report for November. Wall Street is expecting retail sales will moderate from 1.7% to a still strong 0.9% gain. Note that the Chicago Fed retail sales tracker predicts a more modest 0.4% gain.

Monetary Stimulus – Pumping Q1 2022
From a policy perspective, Premier Li Keqiang, Vice Premier Liu He, and the senior economic leadership in Beijing have put top priority on stimulating growth going into and through Q1 of 2022. That is due both to concerns over slowing growth going into the new year, and difficult base effect comparisons to 2021.
The Communique of the 2021 CEWC will be intended to demonstrate that China has made economic stability its top priority for 2022. From the Party’s perspective, “As long as economic growth can be maintained above 5.0% in 2022, we will be able to lay a solid foundation for maintaining average annual economic growth at more than 5.0% during the 14th Five-Year Plan (2021-2025).”

On The Dots
You ask, I answer, now with some quick thoughts on next week’s dot plot.
The theme for the week is my expectation of a high probability that the Fed hikes rates in March. My view is that the balance of risks is changing rapidly, as evidenced by the Fed’s sharp pivot from patience to accelerating the pace of tapering, that March must be considered in play. To be sure, we have three months of data before we get there, so anything can happen, but the data and the Fed narrative shift are driving us in that direction.

Sources in Beijing are eager to present upside pressure on the Chinese Renminbi, even as the US Dollar has also strengthened, as a reflection of powerful and positive trade flows, rebounding investor sentiment, and a long-term movement of trade settlement denominations into the RMB.
But there is a limit to the government’s tolerance for an appreciating currency as the economy recovers from a sharp Q3 2021 slowdown, and officials now warn that they will intervene “if the RMB begins to hurt exports or pose a risk to financial stability.”

Bottom Line
This has the potential to be a fast-moving situation, so uncertainty is once again elevated. Still, at this point I think the most likely path forward is that the Fed accelerates tapering at the next meeting to $30 billion/month. This would both begin to adjust policy to account for supply side nature of shocks and allow the Fed to retain the optionality to hike earlier than June. This would be prudent risk management. I suspect we will see the Fed’s narrative evolve to the effect that there is growing tension between the Fed’s employment and inflation mandate such that the Fed needs to tilt policy a notch toward the latter. They can fit the likely impact of the new variant into such a narrative.

He is clearly saying Omicron will present another supply side shock. It will be slowing progress in the labor market by holding back supply when wage inflation is already “brisk.” It will be adding to inflationary pressures via supply chain disruptions. In short, it’s driving a bigger wedge between the Fed’s employment and inflation mandates. That wedge is already driving the Fed to pivot away from the employment mandate (although I think it can declare full employment whenever it wants) and toward the inflation mandate. Omicron, if realized as another Delta-type wave, would increase, not decrease, the need to pivot toward inflation. The Fed can’t keep easing into supply shocks and FOMC participants know it. Recall also that the Fed sent strong tapering signals during the Delta wave and ultimately pulled forward the taper despite Delta.
Bottom Line: It could be that Powell comes off dovish under questioning, but this testimony is clearly hawkish relative to the September version. I think the short story is that even if inflation is still expected to be transitory, it is now too persistently high to be ignored and Omicron would only make inflation worse. The public doesn’t like inflation, the politics are turning hard against the Fed and the administration, and the quite frankly inflation is comically above the Fed’s mandate, or as Powell says, “overall inflation is running well above our 2 percent longer-run goal.” I don’t think the Fed changes course unless Omicron reveals itself to be something different than Delta. That means assuming the jobs and inflation numbers come is as expected, I expect the Fed will accelerate the taper at the next meeting. Powell though could pull another move like in September and all but promise a faster tapering in January instead. Of course, I am watching for signs that won’t happen, but I don’t see those signs in this testimony.

Debate over Medium Term Forecasts
The need to build optionality in this next, and presumably final, leg of the ECB bond purchase program is predicated on the central bank’s commitment to sequencing lift-off on interest rates only after the completion of its asset programs.
And while the ECB is united (sort of), in pushing back on late 2022 rate hikes, there is a very broad and tacit understanding that these hikes could very well come soon after, in 2023, with considerably less certainty than is projected by the ECB leadership over its medium-term inflation forecasts.
Chief Economist Philip Lane, and ECB President Christine Lagarde, continue to emphasize that judging from where the ECB sits now, the medium term forecast is still for inflation to drop back below its 2% target level after spiking sharply higher this year, due to an essentially mean-reversion assumption that energy prices will fall back down, faith that supply constraints will ease in the fullness of time, and a technical drop off in the German VAT tax effect come January 2022.
In making the case for continued aggressive stimulus, ECB President Christine Lagarde, while acknowledging that prospects for medium term inflation have improved, even went so far as to emphasize in a November 15 speech that by the fourth quarter of 2022, Eurozone inflation could be back down at 1%.
That forecast, however, is due to a year-on-year base effect comparison to the massive spike in inflation now, in the fourth quarter of 2021, and does not reflect any certitude on the far more germane, and unknown, questions over the potential broadening of underlying inflationary pressures and expectations.
In a direct rebuttal to both Lane and Lagarde, Bundesbank President Jens Weidmann warned one week later that “the fallout from the pandemic could have a marked impact on the inflation setting. And it could well be that inflation rates will not fall below our target over the medium term, as previously forecast.”
Policy Implications
For policy purposes, the key point is a concern that the gap between the hawkish and dovish views is in fact not that large.
As stated by ECB Governing Council Member and Belgian National Bank Governor Pierre Wunsch, while the 2023 staff forecast is likely to remain below 2%, “it wouldn’t take much for realized inflation in 2023 to be at 2% — one or two surprises or some second-round effects, so just a fraction of everything we’ve seen in the last three months.”
These differences in forecasts will clearly not be resolved over the next days or even weeks, but the ECB will need to build optionality and policy flexibility for the upside as it gauges the momentum behind underlying inflation impulses going into 2022, including when it rolls out the new “modalities” on December 16 for the 2022 Asset Purchase Program.

Li said that in considering the whole picture of the macroeconomic situation, the MOF should study issuing a new debt quota for local governments in 2022 in advance. The amount of new local government bonds next year can be tentatively set at 4.5 trillion yuan, a slight increase over this year.
(*Note, the annual limit of newly issued local government bonds is usually passed by the country’s legislature and policy advisers in March, after the country’s “two sessions.” But the State Council could be authorized to deliver a part of the quota earlier to accelerate financing for investment projects. China issued 4.47 trillion yuan in new local government bonds in 2021, and 4.55 trillion yuan in 2020).
Li expressed satisfaction with the current monetary policy and reiterated the need to make macro policies more forward-looking and targeted, step up cross-cyclical adjustments, and maintain major economic indicators within the proper range and ensure a stable job market.

“At present, China’s crude oil supply is sufficient, the supply and demand of crude oil is very balanced. Although US President Joe Biden wants China to release its strategic petroleum reserves along with the US, China does not have the need to release our SPR immediately. We will take caution in releasing strategic crude oil reserves,” said one senior source.

In practice, China publicly announced a modest release of its SPR twice over the last fourth months, but our understanding is that China has adjusted SPR data almost every month under its own timetable, without any publicly announcement. Perhaps more to the point, on oil policy, China is keen to maintain its relations with Russia and Saudi Arabia rather than be seen to simply embrace a US request.

European Central Bank officials, concerned by the notion that markets may start pricing “premature” rate hikes some twelve months into the future, have pushed back on expectations of a fourth quarter 2022 liftoff from the current negative 0.5% benchmark deposit rate.
*** But even as they insist that this pricing does not conform to the ECB’s own reaction function and forecasts, our understanding is that there is a strong likelihood the ECB will seek to build some optionality into the revised Asset Purchase Program at its upcoming Governing Council meeting on December 16 to allow for a more rapid run-off of the bond purchasing program should inflationary pressures persist.

Finally, West Virginia Senator Joe Manchin reported on his meeting with Federal Reserve Chair Jerome Powell. Via The Hill:
Sen. Joe Manchin (D-W.Va.) told The Hill that he was “looking very favorably,” but hadn’t made a final decision, on supporting Federal Reserve Chair Jerome Powell if he’s renominated as chairman, after the two spoke on Wednesday.
“Well we’re looking very favorably towards that, because I needed that conversation with him. But I have not made up my mind yet. But I’m just saying that it helped an awful lot having him clear up a lot of the concerns I had,” Manchin told The Hill.
This is a political decision and part of that decision will be the difficulty of getting the nominee confirmed. If Republicans were to be largely united in opposition to one nominee, Manchin would be a critical vote, and his leaning toward Powell could help seal the deal (Democrat Jon Tester also leans towards Powell, Warren of course favors Federal Reserve Governor Lael Brainard).

The last paragraphs of today’s just released speech by influential European Central Bank Board Member Isabel Schnabel have been flagged to us by European Central Bank officials as noteworthy and of particular significance. As many of you are inundated with news and speeches, we are flagging and sending just that key, new takeaway, of her speech as it was highlighted to us below. The speech is clear, excellent, and worth a read in its entirety.
“Eventually, if we are serious about fighting climate change, the green transition will need to bring about a measurable further rise in the price of carbon, which can be expected to lead to higher fuel and electricity prices.

These effects may become entrenched in expectations if people start to anticipate them.

Similarly, some of the bottlenecks we are observing today may not only reflect the reopening of our economy but also structural forces, such as the secular shift to electric vehicles. Adapting supply capacities to such shifts in demand can take several years.[11]
In other words, if some factors that are by nature temporary – such as supply and demand imbalances – are stronger and last longer, then inflation may become more persistent and broad-based.”
In reading that key passage from Dr. Schnabel’s comments, we believe they are especially significant in tying socially desirable, environmentally conscious green policies to inflation, to the risk and potential for higher energy prices to stick longer than initially, and still widely assumed, by the ECB, and to its potentially longer lasting impact on inflation expectations and dynamics.

Bottom Line: The economy is gaining steam in the fourth quarter while inflationary pressures remain elevated. That’s a mix that will push the Fed in a hawkish direction. Watch for the consensus to drift as Bullard suggests, toward starting to lay the groundwork that would allow a policy pivot that accelerates tapering or even pulls rate hikes earlier in 2022. Discount the doves as the Fed has been pulled in the direction of hawkish Presidents because the data runs in a hawkish direction. Places to watch include warnings about high inflation and reassessments of what constitutes full employment.

My focus this week is on the retail sales numbers. The Biden administration and the Fed are spinning a story that goods spending will fall as the economy normalizes and this transition will alleviate inflation. Wall Street, however, is looking for a 0.9% gain in retail sales excluding autos and 0.7% in the control group. Be wary of the potential for an upside surprise. These are nominal figures so inflation may be pushing them even higher. Moreover, note that the Chicago Fed estimates retail sales excluding autos rose 2.6% in October...

This feels to me like a potentially unstable situation. I continue to play with this scenario because it has a knife edge feel. With long yields held down, right now it looks like the Fed doesn’t have a lot of room to cool growth without inverting the yield curve, which suggests we don’t have a lot of space between fast growth and recession. This makes sense in a world where the Fed has flooded the economy with unneeded financial accommodation. The Fed maintained emergency levels of accommodation long after the emergency ended and continues to add accommodation albeit at a slower pace. What strikes me is that this acts with a lag. The maximum impact of the accommodation will be reached after asset purchases stop. That’s a long time to let this system run unimpeded.
I bring up this scenario because it raises the possibility that the Fed may need to focus on reducing the balance sheet before hiking rates. That’s not on the radar yet; we don’t have any visibility on the Fed’s balance sheet plans after asset purchases end. All the discussion is on rate hikes. As we move closer to March, balance sheet policy will need to come into focus. That’s something I will be looking for.

Finally, an even trickier issue. Will the recent trends in fixed income markets continue this week? Recent moves – pulling forward rate hikes, higher short rates, bear flattening – have been sharp and swift. I have been happy to ride that train, but I am getting to the place where I am concerned that these moves are now vulnerable to near-term repositioning. I think part of these moves are attributable to investors caught on the wrong side of the flattening and unwinding positions ahead of month-end. That said, I don’t want to get in front of this train. Powell could do everything I said above and still inadvertently say something market participants perceive as hawkish that won’t be cleaned up for another day or two. Getting off the train but not in front of the train seems like a more comfortable place for me going into this week.