Chapters
Market observations
Heading deeper into the cycle
Iain Cunningham – Head of Multi-Asset Growth, Michael Spinks – Portfolio Manager
Our market outlook and positioning remains at the cautious end of the spectrum. There is increasing evidence that the significant policy tightening witnessed over the past 18 months is beginning to exert an impact, primarily within the eurozone, while also influencing key indicators that we consider leading in the United States.
In developed markets, we believe policy has shifted noticeably from a neutral stance to notably tight, following actions by both the US Federal Reserve and European Central Bank (ECB) coming into 2023. Given the evident time lags, tight policy usually feeds into an economy 6-18 months later. As per the chart below, we are now entering the zone where the impact should begin to become evident, but ultimately, we will not see the full impact of this hiking cycle for another 12-18 months given that policy tightening has, in all likelihood, just peaked.
Fed and ECB hiking cycles – Policy has been tight since late Q4 (Fed)/early Q1 (ECB)
Source: Ninety One, September 2023.
The lags in the US have been longer than in Europe due to higher levels of pandemic excess savings, a positive fiscal impulse and lower levels of variable debt. We would highlight however, that excess savings are likely now run down – according to Federal Reserve measures – and the fiscal impulse is set to fade.
A key component of assessing whether policy is tight is the flow-through to money supply and then into the supply of and demand for credit. Both US and eurozone lending standards have tightened considerably and credit growth has slowed sharply in recent months – as evidenced below by material declines in credit impulses. These usually impact higher frequency economic data in six to nine months. Note that China’s credit impulse did this in Q2 2021. We expect further progression into negative territory for these measures while policy is this tight and this will be a significant constraint on developed market growth.
Senior loan officer surveys
US credit impulse
Source: Ninety One, September 2023. *Commercial and Industrial.
In Europe we are seeing a faster feedthrough into higher frequency economic data releases due to there being less supportive factors vs. the US, as noted above. Data releases have been weakening across the board which has added conviction to our central scenario that Europe is entering a downturn with policy now at a notably tight setting. Ongoing declines in eurozone money supply growth and the region’s credit impulse should add further headwinds to growth and inflation in the coming quarters. We do not believe these dynamics are currently being reflected in the pricing of European assets with expectations still relatively sanguine about the outlook. As a result, we believe that the degree of dislocation between current market pricing and prevailing fundamentals leads to significant asymmetry and provides an opportunity to take contrary positions.
Eurozone M2 money supply growth
Eurozone credit impulse
Source: Ninety One, September 2023.
In China, our central case remains more constructive than the consensus on the outlook for the economy over the medium-term, one-to-two-year view. Our expectation continues to be for a bumpy but sustained recovery, driven by a reopening from COVID lockdowns and targeted stimulus measures against the well-known backdrop of indebted property and local government sectors. The communications since July’s Politburo meeting had some notable highlights. This included dropping the phrase that ‘houses are for living, not for speculation’ and calling for ‘implementing a comprehensive debt solution’ for local government financing. Multiple measures have subsequently been announced to stimulate activity, the most important factors to highlight are primarily the measures targeting the housing market. We expect the relaxation of the first-time buyer definition across the large cities, the reduced down-payment rules and the lower borrowing costs to be particularly effective. Additionally, fiscal measures include an increased pace of local government bond issuance and measures to deal with stretched local government balance sheets.
There is a compelling risk premium present in the many developed sovereign markets, with positive real yields providing valuation support. At a time when both the Federal Reserve and ECB are at or close to the end of their hiking cycle and with leading indicators of growth momentum notably slowing because of now tight policy settings, we expect nominal bond yields in developed markets to face downward pressure over the medium-term.
We remain cautious on the outlook for developed market equities and credit where valuations remain extended versus our prospective outlook for growth and earnings. In China, we expect the moves by authorities to stimulate activity and liquidity to provide support to risk assets specifically in China.
