The US Federal Reserve has downplayed the possibility of a rate hike as its next policy move. Its focus is on how long it should maintain the current target range for the fed funds rate, and the next move is still likely to be a cut. In Asia, Chinese policymakers have signalled more policy easing to prop up the ailing property market. The market still expects the Bank of Japan (BoJ) to raise interest rates, but uncertainty about Japan’s growth and inflation outlook and the yen’s weakness have constrained expectations of how far the BoJ could go.
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Fed shifts to a balanced strategy
When the Federal Reserve left the key federal funds rate unchanged at 5.25-5.50% at the last meeting of the Federal Open Markets Committee (FOMC) on 30 April/1 May, it also pushed back against the suggestion that the next move would be an interest rate hike. The Fed said it would slow the pace of quantitative tightening starting in June by cutting the monthly run-off rate of US Treasuries from USD 60 billion to USD 25 billion.
Fed Chair Powell emphasised in the post-meeting press conference that the choice was between leaving rates on hold and cutting them. Benign US labour market data in April lent support to his view that a further rate hike is highly unlikely: Non-farm payrolls rose by 175 000, less than expected, the unemployment rate nudged up to 3.9% (versus an expected 3.8%), and average hourly earnings growth fell to 3.9% year-on-year.
The next (April) consumer price inflation report on 15 May is likely to show a continued decline in the inflation rate. Rising productivity should help sustain the downtrend of the Fed’s favourite inflation gauge, the core personal consumption expenditures (PCE) index, towards the official 2.0% target (Exhibit 1).
Restrictive lending by commercial banks is helping to constrain inflation. The latest (April) Senior Loan Officer Opinion Survey (SLOOS) again showed a widespread tightening of lending standards for both consumer and commercial loans.
In this cycle, the Fed’s tightening of monetary policy has brought inflation down while keeping the labour market reasonably steady (Exhibit 2), thus fulfilling the Fed’s dual mandate.
The Fed’s current stance reflects a shift from its hawkish strategy at the onset of this cycle of ‘taming inflation at all costs’ to a balanced approach of keeping prices and employment stable.
Under the higher-for-longer US rate outlook, our investment committee has trimmed its duration exposure and Treasury Inflation-Protected Securities (TIPS) position while remaining long sovereign bonds overall.
The disinflationary growth outlook, with a view toward looser monetary policy, alongside signs of a global manufacturing recovery, has prompted us to move equities to a neutral weighting, with a small increase in our allocation to US tech stocks.
China signals more easing
At its most recent meeting, the Politburo signalled further stimulus to come and reiterated its focus on structural reforms. Beijing’s pledge of more support for the economy has helped lift Chinese stock markets by almost 20% from February’s low.
Since late 2023, the authorities have been injecting an increasing amount of net liquidity into the economy. They have now upped the ante, announcing a shift towards rescuing the debt-laden property sector by absorbing excess housing inventories, increasing the supply of housing to meet demand for higher-grade homes, and lowering the costs of these changes.
If implemented properly, these measures could be a game changer for economic growth and the outlook for asset markets.
However, there was no major stimulus announced for the private sector or consumption-driven growth. Instead, China’s leaders reaffirmed the state-led investment-driven model unveiled at the National People’s Congress meeting in March. This focuses on fiscal pump-priming to develop ‘new quality productive forces’ with limited direct support for consumption.
This should favour large capitalisation stocks and sectors aligned with the government’s direction of reform.
Limits to Bank of Japan policy normalisation
After the initial euphoria of Japan escaping decades-long deflation, expectations for BoJ policy normalisation or significant increases in policy rates have been lowered. Markets are now pricing BoJ rates to rise by barely 1% over the next five years. So it was no surprise to see the yen fall against the US dollar to a 34-year low recently.
A looser BoJ policy and a weak yen have, however, supported Japanese stocks, with the Nikkei 225 index up by 17% year-to-date (in local currency terms).
We have reduced our overweight to the Japanese yen, but remain overweight Japanese equities relative to our benchmarks.
The BoJ is cautious about another rate hike at this point because of the potentially negative effect on the economy, especially in the absence of a recovery in consumption and services prices. Currently, the market expects first quarter 2024 GDP and consumption data, due for publication on 16 May, to show a contraction in activity, and the Tokyo consumer price index in April to show no sign of a recovery in services prices.
