RMB tail wags US inflation dog

Remarkably, the best predictor of US inflation expectations during the past three years is the RMB’s exchange rate against the US dollar. That’s because the marginal item bought by an American consumer with the $6 trillion of pandemic stimulus handouts is likely to be imported, and likely to be imported from China. China’s exchange rate affects the prices of so much of America’s goods consumption that the RMB moves inflation expectations in the US.

The regression fit of the RMB exchange rate against the 5-year 5-year forward inflation rate is 80%. More importantly, it is significant at the 99.99% confidence level in a first-difference regression, which means simply that the likelihood is vanishingly small. that the relationship is spurious

Of course, the reverse also is true: The RMB is a hedge against US inflation. Chinese bonds pay a positive real yield (the 5-year Chinese government bond yields about 2.5% with an inflation rate of around 1%, while the US 5-year note pays 1.9% with an inflation rate of 7.5% and a 5-year expected inflation rate of about 3%).

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