BNP AM

The sustainable investor for a changing world

Front of mind | Article - 4 Min

Weekly Market Update – Policy shift: are we there yet?

The pace of inflation in developed markets has slowed, while China’s economic weakness appears to have hit a ‘pain point’ that has finally got  Beijing’s attention. The big question for financial markets is whether we are finally seeing the first signs of a shift in monetary policy towards easing. Developed market central banks are still wary of cutting rates too soon, but China’s central bank has recently moved more assertively.  

Despite a fall in inflation…

The markets’ key focus is still very much on inflation. Last week’s consumer price reports in Europe, the UK and the US did not disappoint those anticipating a softening of inflationary pressures.

US headline and core consumer inflation rates slowed to 3.2% year-on-year (YoY) in October from 3.7% in September and to 4.0% from 4.1%, respectively. Crucially, ‘supercore’ inflation (nonhousing core services) – the measure seen as mattering the most to US Federal Reserve policymakers – rose by only 0.2% month-on-month. US stocks jumped for joy, rising by almost 2.0% on the day of the news.

The falling inflation trend suggests the Fed could now revise down its 2023 year-end core inflation forecast when it publishes new projections at its meeting on 12-13 December. In our view, this makes the (already faint) prospect of another rate hike even more remote, at least for now.

Headline inflation also slowed in Europe. It fell to 2.9% YoY in October from 4.7% in September, while the core rate softened to 4.2% YoY from 4.7%.

Even in the UK, which faces the biggest inflationary pressures among the major economies, October headline and core inflation fell to 4.6% and 5.7% YoY from 6.7% and 6.1%, respectively, in September.

…the crystal ball is still murky

However, leading central banks remain cautiously hawkish, warning that future decisions on monetary policy depend on the strength of the economy and progress towards their inflation targets. They need the prevailing tight financial conditions to persist. In the meantime, their crystal ball for predicting inflation remains murky.

Despite the recent decline, core inflation in all major developed economies is still far above central bank targets (see Exhibit 1). This suggests a period of sub-par growth may be necessary in these economies to bring core inflation back to the 2.0% targets.

Major inflation and macroeconomic gauges for the US (and for the other major central banks) are not (yet) consistently signalling a slowdown. In the US, there appears to be no clear evidence that consumers are expecting inflation to fall back toward central bank targets. 

Fourth-quarter 2023 inflation projections from the Survey of Professional Forecasters by the Federal Reserve Bank of Philadelphia show headline CPI inflation averaging 2.4% over the next 10 years. This contrasts with the higher (3.2%) average rate implied by the University of Michigan survey of five to 10-year inflation expectations this month. What’s more, the University of Michigan measure has risen by a substantial 40bp since September 2023.

Ambiguous US employment data also justifies the Fed’s caution. While October’s non-farm payrolls surprised to the downside, job growth was still strong on a three-month average basis. Meanwhile, job gains recorded in the household (HH) survey data were much weaker than those in the payroll data (see Exhibit 2).

Conflicting signals like these are not new, but they contribute to the uncertain outlook for monetary policy and make market positioning difficult.

Experience suggests that only when the economy has entered a persistent slowdown, notably a recession, do the declines in employment and inflation expectations in the various surveys tend to align.

This implies that the ‘higher-for-longer’ rate view should prevail before monetary policy intentions shift towards an easing mode. That shift will require the major macroeconomic indicators to show: 

  • Sub-trend GDP growth
  • Unemployment rising towards or above the equilibrium rate (or other signals of significant labour market weakening such as a decline in the pace of wage growth)
  • Core inflation falling clearly and consistently towards the 2.0% target rate. 

China – More aggressive easing

Meanwhile, China’s uneven economic recovery rumbles on as policymakers continue to mull over the question of additional support for the struggling property sector.

China’s macroeconomic data in October showed considerable divergence across sectors, with retail sales and industrial production still growing moderately, but fixed-asset investment slowing, in part due to further deterioration in the property sector.

While the latest data is consistent with delivering the 5.0% official growth target this year, we believe Beijing will need to stabilise the property sector to prevent momentum from faltering. And it appears the authorities are preparing more assertive measures, with the People’s Bank of China considering injecting at least RMB 1 trillion to fund three major property and infrastructure projects in big cities.

Such a move would come on top of the recently announced RMB 1 trillion of public spending for the rest of 2023. Should push comes to shove, which now appears to be the case, we believe the PBoC has ample leeway to ease policy by monetising debt to fund fiscal spending.

Despite all its talk of policy easing, the PBoC did not expand its balance sheet aggressively during the pandemic to pump-prime the economy – unlike its developed market counterparts (see Exhibit 3).

If Beijing can sustain its assertive policy in the coming months, rebuild confidence and convince markets that the outlook is improving, we believe there is a fair chance of a sustained rebound in Chinese GDP growth and stock valuations in 2024. If not, growth could remain stuck in low gear, keeping a heavy lid on asset prices.

Little room for error

In the face of such a widespread precarious macroeconomic and policy backdrop, there is little room for error in market positioning.

We lean towards a defensive posture by favouring government bonds over equities until such time as the economic and policy dynamics change again, or at least until the fog clears.

Disclaimer

Please note that articles may contain technical language. For this reason, they may not be suitable for readers without professional investment experience. Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice. The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns. Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions). Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

Related insights

Fixed income outlook: the hunt for inflation
US economy to motor on, though bumps in the road remain
BNPPAM

In the U.S., this material is for Institutional use only – not for public distribution. This material is provided for educational purposes only and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be and should not be interpreted as recommendations. Reliance upon information in this material is at the sole risk and discretion of the reader. The material was prepared without regard to specific objectives, financial situation or needs of any investor.

These documents and video clips may also include information obtained from affiliated investment management companies within BNP Paribas Asset Management, the brand name of the BNP Paribas group’s asset management services. The documents and video clips are produced for informational purposes only and do not constitute: 1. an offer to buy nor a solicitation to sell, nor shall they form the basis of or be relied upon in connection with any contract or commitment whatsoever or 2. investment advice. Any opinions included in these documents and video clips constitute the judgment of the author/ presenter at the time specified and may be subject to change without notice.

This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections, forecasts, and estimates of yields or returns. No representation is made that any performance presented will be achieved by any funds, or that every assumption made in achieving, calculating or presenting either the forward-looking information or any historical performance information herein has been considered or stated in preparing this material. Any changes to assumptions that may have been made in preparing this material could have a material impact on the investment returns that are presented herein. Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy.

The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by BNP PARIBAS ASSET MANAGEMENT USA, Inc. to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy.

The information provided here is neither tax nor legal advice. Investors should speak to their tax professional for specific information regarding their tax situation. Investment involves risk including possible loss of principal. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation, and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are often heightened for investments in emerging/developing markets or smaller capital markets.

FOR INSTITUTIONAL AND FINANCIAL PROFESSIONAL INVESTOR USE ONLY. THIS MATERIAL IS NOT TO BE REPRODUCED OR DISTRIBUTED TO PERSONS OTHER THAN THE RECIPIENT.

BNP Paribas Asset Management seeks to integrate environmental, social and governance (“ESG”) factors into all of our portfolios as a means to mitigate certain short, medium and long-term financial risks, identify better long-term investments, and encourage more responsible corporate behavior. We will never subordinate our client’s interests to unrelated objectives. Certain issuers and industries are excluded from our actively managed portfolios based upon our view of their ESG performance and risk profile. As a result, we may pass up certain opportunities when these excluded issuers or industries are in favor. Due to significant gaps in disclosure regimes around the world, we may need to rely upon voluntary disclosures by issuers, which are often not audited. We therefore may not have consistent access to complete, accurate or comparable information about the ESG performance of our holdings. Please consult the applicable offering document for more information about the specific ESG strategy employed by each investment strategy since a given strategy may not have specific ESG guidelines, and investments are not limited to securities that are ESG compatible.

BNP PARIBAS ASSET MANAGEMENT USA, Inc. is registered with the U.S. Securities and Exchange Commission as an investment adviser under the Investment Advisers Act of 1940, as amended. BNP PARIBAS ASSET MANAGEMENT USA, Inc. is a registered trademark of BNP Paribas or its subsidiaries in the United States and elsewhere. All other trademarks are those of their respective owners. © 2024 BNP PARIBAS ASSET MANAGEMENT USA, Inc., All rights reserved.

BNP PARIBAS ASSET MANAGEMENT is the global brand name of the BNP Paribas group’s asset management services. © 2024 BNP PARIBAS ASSET MANAGEMENT USA, Inc., All rights reserved.

To access insights from our teams worldwide visit:
BNP AM
Explore VIEWPOINT today