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Weekly investment update – Central bank policy tightens while risk shifts

This material is intended for Institutional Investors (as defined in the Securities and Futures Act, Chapter 289 of Singapore) only and is not suitable or intended for persons who do not qualify as such.

The Federal Reserve has raised  its benchmark policy rate by a sizeable 50bp to rein in robust inflationary pressures, confirming market expectations that had seen the traded-weighted US dollar index and US Treasury yields rise sharply, taking the 10-year Treasury yield to 3% for the first time since 2018.  

Attention now shifts to the next meeting of US policymakers in June as investors look for clues as to whether the latest move marks the start of a longer series of 50bp rate rises. The focus is also on the European Central Bank, whose policy tone has turned increasingly hawkish as inflation rose further in April while eurozone GDP growth during the first quarter rose to above its pre-Covid level.

For now, it appears the biggest near-term threat to global growth has shifted from the Ukraine conflict to China, which last week reported a plunge in the purchasing managers’ index (PMI) to its lowest since the 2007-08 Global Financial Crisis (GFC) amid Covid-related lockdowns.

More Fed tightening on the cards

In addition to the widely expected rate increase, the US Federal Reserve (the Fed) announced that it would start shrinking its balance sheet in June. High inflation and a tight labour market underpin Wednesday’s policy tightening.

The US central bank appears to have shrugged off a drop in first-quarter GDP growth to 1.4% quarter-on-quarter (QoQ) due to a large trade deficit. Domestic demand was strong, with imports surging by 17.7% year-on-year (YoY) in the quarter. The Institute for Supply Management’s (ISM) manufacturing index for April came in slightly softer, but continues to indicate expansion. So, to us, any apparent weaknesses look unlikely to deflect the Fed’s tightening plans.

Meanwhile, inflation as measured by the Fed’s preferred gauge of inflation, the Personal Consumption Expenditure (PCE) index, rose to 7.0% in first quarter 2022, with the core rate rising to 5.2%. That is still far above the Fed’s 2% inflation target. The tightness of the labour market was reflected in the employment cost index (ECI) for the first quarter. It rose by 1.4%, its fastest quarterly pace since 1989 (Exhibit 1).

Markets welcomed comments by Fed chair Jerome Powell that the next couple of policy meetings would likely see 50bp increases, but bigger 75bp moves would not be considered unless inflation/wages data came in very strong in the coming months.

We believe taking the 75bp option off the table suggests that the Fed could pivot back to 25bp hikes from September. This came as a relief to markets, which reacted strongly after the Fed’s announcements: US equities rallied (the S&P 500 gained almost 3%, its best day in two years), the US dollar depreciated and the bond yield curve steepened.

Next up – The ECB

In the eurozone,  first quarter 2022 GDP grew by a solid 5.0% YoY, 0.4% above the pre-Covid level in the fourth quarter of 2019. The unemployment rate fell by 0.1% to 6.8%, which was below the European Central Bank’s (ECB) forecast of 7.3% for 2022. Inflation remained high at 7.5% YoY in April, with the core rate running at an above-target 3.5% YoY. We believe all this justifies the ECB becoming more hawkish recently.

That said, growth momentum slowed, with the European Commission’s confidence survey for April showing a modest decline in both business and consumer sentiment as high inflation eroded purchasing power and the war in Ukraine fanned uncertainty about the outlook.

Our research team now expects the ECB to end its Asset Purchase Programme in July this year, and to start raising interest rates by 25bp in September, then again in December, followed by four 25bp increases in each quarter of 2023.

Growth risk shifts to China

Growth in China has been flagging due to Beijing’s stringent zero-Covid policy to curb the Omicron outbreak. The risk of an economic contraction in second quarter 2022 is rising. Not only does this threaten the government’s 5.5% growth target for 2022; it could also send another shockwave through global supply chains.

China’s official manufacturing Purchasing Manager’s Index (PMI) dropped to 47.4 in April from 49.5 in March, while the non-manufacturing PMI plunged to 41.9 from 48.4. The Caixin manufacturing PMI, which includes many small and medium-sized firms in coastal regions, fell to 46.0 from 48.1 in March as logistics disruptions hit major coastal cities such as Shanghai, Jiangsu and Fujian, significantly damaging their manufacturing activity and exports.

Since China’s economy accounts for nearly 20% of the global economy, weak Chinese demand would temper exports to China, notably goods from Asia, capital expenditure-related materials from Europe and the US, and commodities from Latin America.

Slowing China production and shipping would disrupt global supply chains just as the world’s demand and production were expected to bounce back after the Omicron wave in Europe and the US.

More easing to come in China

At last week’s Politburo meeting chaired by President Xi Jinping, Beijing vowed to double-down on efforts to stabilise the economy, although it stopped short of changing its zero-Covid policy in the short term.

The Politburo called for stronger countercyclical easing, using all monetary policy tools and drafting additional expansionary measures. It specifically called for enhancing investment in digitalisation infrastructure, clean energy, transport and logistics in major city clusters, as well as investment in water conservancy and rural infrastructure. These efforts should boost the recent recovery in infrastructure growth, which is expected to do the heavy lifting in maintaining GDP growth (Exhibit 2).

Beijing has already pressured local governments to increase construction and ease property market measures. The Politburo also asked local governments to 

  • Ease housing regulations, in particular on home upgrade demand and housing pre-sale proceeds in escrow accounts
  • Increase fiscal and local government funding support to small and medium-sized companies
  • Speed up construction project approvals. 

In response to recent market turbulence and a sharp equity downturn led by the tech sector, the Politburo explicitly called for measures to support the sector while wrapping up regulatory work.

This should be good news for Chinese internet and e-commerce companies, as it signals a significant reduction of regulatory uncertainty that has been hampering the equity market for more than a year.


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. This material is produced for information purposes only and does not constitute: 1. an offer to buy nor a solicitation to sell, nor shall it form the basis of or be relied upon in connection with any contract or commitment whatsoever or 2. investment advice. It does not have any regards to the specific investment objectives, financial situation or particular needs of any person. Investors should seek independent professional advice before investing, or in the absence thereof, he/she should consider whether the investments are suitable for him/her.

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