Divergence is a key theme in global markets now, with the manufacturing side of many economies much weaker than the services sector, although services activity has also been cooling recently. Inflation data is also diverging – across different regions: price pressures have remained sticky in Europe and the UK; those in the US and many emerging economies have eased.
Where inflation has been slackening, central bankers have begun mulling over whether to stop raising interest rates or already start easing monetary policy (as has been the case in some emerging markets). This has prompted our multi-asset investment teams to overweight emerging market bonds, alongside our overweight position in developed market bond duration.
Markets and fundamentals
Wall Street was rocked last week when Apple, the largest listed tech company, lost some USD 200 billion in market capitalisation in just two days after China was reported to have banned the use of Apple’s phones in government offices and state companies. While a shock development, analysts estimate the hit to sales would be only about 1% in the coming year.
China later clarified it hadn’t issued any ban of iPhones or other foreign phone brands and highlighted media reports on security incidents and the importance of cybersecurity and the prevention of data theft. The comments appeared to remove market concern over what would have been an unprecedented blockade as part of Beijing’s multi-year efforts to root out foreign technology use in sensitive environments.
As this ‘China dust’ settles, we expect financial markets to return their focus to the fundamentals – US Federal Reserve (Fed) policy expectations and interest rate paths, energy prices, China’s growth outlook, the risk of stagflation – and how such a mix of factors may affect global market dynamics.
Expectations that the US economy is heading for a soft landing are gradually becoming a base case for market observers as the effects of monetary tightening are being felt in other developed markets.
The recent mix of good and bad indicators leaves us with no clear signals concerning the timing of a monetary policy shift by the Fed and the other major central banks. While they appear comfortable with their current policy stance, the overwhelming indication is still that the fight against inflation is not yet over.
The Fed appears torn between tightening policy further or pausing as its focus shifts to the decline in US household savings, which have shrunk much faster than in other developed markets. Until now, excess savings have helped support US consumer spending and economic growth; their decline could be a warning that the economy will lose steam.
The eurozone economy is also showing signs of slowing as monetary tightening starts to bite. Growth indicators – notably the August purchasing managers’ index (PMI) and Germany’s weakening industrial activity – are signalling stagnation. The EU Commission has cut its forecast of eurozone GDP growth to 0.8% YoY this year from 1.1% earlier; it also sees Germany’s GDP contracting by 0.4% this year.
Much will depend on how labour markets fare. Unemployment rates are yet to pick up meaningfully to slow inflation as the number of jobs has still been growing (although more slowly).
Wage growth has thus remained high in Europe, and notably so in the UK, contributing to the stickiness in services inflation. In the US, nominal wages are still rising at more than 4.0% a year, which remains inconsistent with the Fed’s 2.0% core inflation target.
More easing by China
Meanwhile, China’s growth outlook (especially that of its ailing property market) remains a global concern, though there now is evidence of broader easing measures from Beijing. August credit data beat market expectations, lifting aggregate credit growth to 9.3% year-on-year from 8.9% in July and the credit impulse by 80bp to -2.2% (Exhibit 3), driven by greater government bond issuance.
Beijing plans to issue RMB 1.5 trillion of special government bonds to swap for local government financial vehicle debts of 12 provinces in the coming months. Although this amount is small compared to total outstanding LGFV debt (estimated at RMB 78 trillion to RMB 96 trillion, or 64-79% of GDP, in 2022), it signals support for local governments and by extension the property market. The People’s Bank of China is considering setting up a special purpose vehicle to provide liquidity for LGFVs to pay off debt and arrears.
These moves should help ease market concerns over systemic risk.
Beijing has also stepped up its efforts to reduce the property market’s difficulties. All four tier-1 cities have announced a relaxation of property controls. The Shanghai and Shenzhen Stock Exchanges recently signed a memorandum on supporting financing to private property developers.
The most significant move has been the joint effort by the monetary and regulatory authorities to loosen down-payment requirements for home purchases nationwide, lower the mortgage rate floor and reduce existing mortgage rates for the first time since the Global Financial Crisis.
These measures are focused on the demand-side of the property market. We believe Beijing still needs to resolve developers’ financing problems by further monetary easing.
No Chinese deflation
Investor concern over China falling into deflation was dispelled by the August consumer price index. CPI inflation turned positive after falling below 0% in July.
This underscores our recent argument that prolonged deflation would be unlikely in China because the pre-conditions for deflation are absent.
Money supply is still expanding, though the growth rate has been slowing. There are no worrying signs of demand destruction outside of exports. Income growth is slowing, but not contracting. Consumer demand is recovering and overall labour market conditions are not dire. Consumers have been drawing down saving to fund spending, indicating there has been no permanent loss of confidence.
Provided Beijing continues to act to shore up economic activity and business and consumer confidence, we believe the current pessimism will not become entrenched and hit growth more heavily.