Asset Management: Monthly Macro Insights - October 2023

Most investors continue to foresee the resilience of the global economy despite the fastest global monetary policy tightening in four decades. However, not only the impacts of the latter are increasingly visible on economic activity, but the rise in crude oil prices and higher bond yields since midyear have raised new concerns regarding the goldilocks scenario.

Regional divergences persist

Helped by lower energy prices, a substantial fiscal stimulus and China’s decision to abandon its zero-Covid policy, the global economy surprised to the upside in the first months of 2023. However, the resilience in global growth seems to have been short-lived.

In the Eurozone, growth has broadly stagnated since Q4-2022, and the S&P Global business confidence index suggests the GDP could drop by -0.4 per cent q/q in Q3-2023 if past historical correlations hold, which differs from investors’ expectations of a small rise.

In a very close vote (5-4), the Bank of England (BoE) left its monetary policy unchanged in September, ending a string of fourteen consecutive rate hikes as policymakers noted mixed developments in the past months. Overall, the BoE is seeing increasing signs of the restrictive impact of tighter monetary policy on the labour market and activity more broadly, and thus decided to pause, although it’s very clear that another hike remains on the table if needed.

Meanwhile, growth in China has lost momentum, with the initial impetus from reopening fading, although activity data from August suggest that the economy’s slump may be starting to bottom out. While optimism is slowly building that the authorities’ recent efforts to boost the economy are starting to bear fruit, some challenges remain, especially as structural problems in the property sector continue to weigh on domestic demand.

By contrast, the US economy has so far proved unexpectedly resilient, with household spending supported by a run-down of excess savings accumulated during the pandemic. Furthermore, fiscal policy played an unappreciated role.

Higher for longer

Although headline inflation in most G20 advanced economies has roughly halved from peaks seen in 2022, most of the adjustment is explained by commodity prices’ base effects. In fact, core inflation has yet to turn down decisively, held up by cost pressures and high margins in some sectors. Therefore, central banks have insisted monetary policy would remain tight for some time, despite investors somewhat downplaying the warning. The recent rise in sovereign yields suggest that the message is finally sinking in.

In addition, higher commodity prices could give new impetus to headline inflation. The rise in yields can also be explained by risks regarding public finances. Correspondingly, efforts to rebuild fiscal space and credible medium-term fiscal plans seem inevitable to ensure debt sustainability and calm the global bond selloff.

The upshot is that the policy mix divergence – tight monetary policy, and loose fiscal policy – is ending with the tailwind on the economy from fiscal largesse fading rapidly. Although the lags might have lengthened, some investors might end up being caught off guard when the full impact of monetary tightening is reached.