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.


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.

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