Markets: an East/West divide

"Stagflation[1]" (stubbornly high inflation and slowing economic growth) is creating a monetary policy dilemma for Western central banks: Should they tighten policy further to lower inflation, when weak growth would argue for lower rates? On the other hand, with falling inflation and more favorable growth prospects in emerging markets in Asia, boosted by China's reopening, Eastern central banks face less daunting challenges. This gap could direct portfolio flows to Asian and Chinese asset markets in the coming months.

U.S. employment numbers remain strong

The long-awaited January CPI inflation rate released on February 13 was 6.4% year-on-year, slightly below the 6.5% recorded in December. On a monthly basis, however, the official rate increased from 0.1% to 0.5%. While oil prices keep total CPI high, core inflation rose sharply by 5.6% year-on-year in January after rising 5.7% in December.

The report shows a slight decline in inflationary pressures, but the current rate remains well above the US Federal Reserve's (Fed) target of 2%. The Fed is not comfortable with the strength of the US labor market and the risks of a wage-price spiral. In January, wage growth was 4.4% year-on-year and the unemployment rate fell to 3.4%, a 53-year low.

All of this helps explain Fed Chairman Jerome Powell's recent view that "the process of disinflation has begun," but further interest rate hikes may be necessary if the job market remains strong. In the second week of February, he publicly stated that he did not expect inflation to fall to 2% until 2024.

East-West inflation gap

The gap between the Western and Eastern markets is reflected in the gap in inflation rates (see Chart 1). Inflation in the G3 economies (Europe, the United Kingdom and the United States) averaged 9% year-on-year in December 2022, while in Asia (excluding China) it averaged only 5% year-on-year.

China's inflation is among the lowest in the world. Its December 2022 total CPI rose just 2.1% year-on-year, with core inflation of 1.0% year-on-year. China's producer price index (PPI) has been deflating since September 2022 and fell 0.8% year-on-year last month. There is no risk of monetary policy tightening in China.

Given China's low inflation rate and an unappreciating renminbi, China does not export inflation to the rest of the world. Given the supply chain between Asia and China, the region is benefiting from the fallout from China's disinflationary impact.

Difficulties in the West…

Macroeconomic indicators highlight the risk of recession in the West. In particular, the US yield curve remains inverted. The recent survey of loan officers pointed to an upcoming economic slowdown as banks tightened their lending criteria due to a slowdown in loan demand.

In Europe, the preliminary estimate of euro area GDP growth in the fourth quarter of 2022 is just positive (0.1% quarter-on-quarter). However, the breakdown of the data showed a sharp decline in household spending. Other statistics indicate low consumer confidence and mixed investor sentiment.

Japan's Q4 2022 GDP grew 0.6% quarter-on-quarter below, nearly 1% below the pre-pandemic Q4 growth rate in 2019.

… but optimism in the East

At the same time, the reopening of the Chinese economy has boosted optimism about Asian growth and demand for raw materials. While it will still take time for the improvement in key macroeconomic indicators to reflect the impact of the recent easing of monetary policy, Lunar New Year data already show a strong rebound in domestic demand in the mobility and services sector. Bank lending, generally a leading indicator of economic activity, rose 11.1% year-on-year in January (see Chart 2), better-than-expected growth.

The expansionary impact of China's reopening is likely to spill over to Asia, helping to offset some of the slowdown in growth in developed markets. Sino-Asian trade is now more important than Sino-US trade, so open economies that are more exposed to China than to Western countries should benefit more from China's recovery.

Net exporters of raw materials, particularly oil, are also expected to benefit from trade conditions, as improving Chinese demand tends to tighten global commodity markets at the margin. Finally, tourism-dependent economies, especially those that depend on Chinese visitors, have upside potential.

The reopening of China has led our investment teams to increase their allocation to EM equities, due to attractive valuations and upward earnings revisions expected in the coming months.

FOR MORE DETAILS ON OUR ASSET ALLOCATION, CLICK HERE.

Warning

Please note that articles may contain technical terms. For this reason, they may not be suitable for readers who do not have professional investment experience. The 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. Portfolio management teams may have different opinions and make different investment decisions for different clients. This document does not constitute investment advice. The value of investments and the income they generate can move down or up, and investors may not get back their initial investment. Past performance is not indicative of future performance. Investments in emerging markets or specialised or restricted sectors are likely to be subject to above-average volatility due to a high degree of concentration, increased uncertainties resulting from less information available, less liquidity or greater sensitivity to changes in market conditions (social conditions, political and economic). For this reason, portfolio trading, liquidation and custody services on behalf of funds invested in emerging markets may be riskier.

Termes et définitions
1. Stagflation ( Stagflation ) La stagflation est un phénomène économique caractérisé par la conjonction d’une stagnation économique et d’une inflation élevée. Cela…
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