The resurgence in global uncertainty and the specter of a choppier investment backdrop topped the list of subjects covered in our September global-strategy meeting.
Europe keeps stagnating, the U.S. remains resilient and China's momentum is faltering. Inflation surprises were more benign across the board, but the jump in prices for oil and some food categories adds near-term volatility to the disinflationary trend. Several emerging-market central banks are lowering rates, while in the industrialized world, cuts are nowhere in sight. In some developed economies, in fact, the door for additional tightening is still open. Markets are struggling with these crosscurrents. After successfully weathering the steady rise in long-term U.S. rates into July, global stocks took a dive over the past month. Concerns over China's economy, which stocks elsewhere in emerging markets had shrugged off, began to contaminate broader risk sentiment. The dollar, meanwhile, gained further ground, nearing its 2023 high. And more volatility may be in store. GSM participants were cautious as they evaluated these crosscurrents, which are unlikely to be resolved in the near term and seem to be leaving markets without clear direction.
Markets are struggling with these crosscurrents. After successfully weathering the steady rise in long-term U.S. rates into July, global stocks took a dive over the past month. Concerns over China’s economy, which stocks elsewhere in emerging markets (“EM”) had shrugged off, began to contaminate broader risk sentiment. The dollar, meanwhile, gained further ground, nearing its 2023 high. And more volatility may be in store. GSM participants were cautious as they evaluated these crosscurrents, which are unlikely to be resolved in the near term and seem to be leaving markets without clear direction.
China: Sluggish yes, crash no
Incoming data from China keep pointing in the direction of sluggishness. Policymakers announced additional stimulus efforts, including a broader set of measures to tackle the property sector’s woes that, based on anecdotal evidence, appear to be gaining some traction. These stories of disappointing activity and timid policy responses have been playing out for several months. But more recently, the underwhelming growth picture appears to be fueling some investors’ fears that China is about to see a deep cyclical slump or a Japan-like deflationary bust—scenarios that would force a fundamental rethinking of EM assets.
Our macro analysts found these fears overdone. They argued that the more likely path is a further structural deceleration—a process that has been ongoing for over a decade—without a crisis. First, they observed, China has buffers to prevent a disorderly adjustment, principally a central government with room to lever up and control over the financial system, plus a closed capital account. Second, it isn’t obvious that China has the types of severe imbalances seen prior to past financial crises, such as Asia’s 1997 crisis or the 2008 financial crisis. Households are not overleveraged and there has not been a sharp runup in home-to-income ratios, in contrast to the Japanese experience. A sudden stop in funding, moreover, is unlikely given the predominantly state-controlled structure of China’s financial system. While recent tensions in shadow banking require monitoring, some evidence suggests systemic risks are more limited because the government has cracked down on the sector since 2017.
Persistent divergences
Persistent divergence in growth trends between major economic blocks again became an area of focus. Activity in the U.S. is showing no signs of slowing, and many investors have pushed their expectations for a slowdown or recession farther into the future. In just the past three months, 2023 consensus growth estimates nearly doubled to 2% (see Figure 1). The resilient outlook for the U.S. sharply contrasts with Europe’s, where the latest batch of data— weak PMIs and a slight upside in inflation—points to stagflation. The gap between upbeat U.S. and disappointing Eurozone economic surprises is narrowing but remains at historically wide levels. China’s economic surprises echo the disappointing trend in Europe. Growth revisions in the rest of EM are still creeping up amid upside surprises in Brazil and Mexico, among others.
Today’s picture differs significantly from the synchronized upswing from early 2023, which was also a period of more generalized asset-price gains. Disinflation, at various speeds, has been the norm globally, but monetary-policy cycles have continued to diverge. The U.S. Federal Reserve and European Central Bank are approaching the end of their tightening cycles but DM cuts are still not in the cards. Easing cycles in parts of EM are well underway, yet markets are differentiating between orthodox central banks with room to ease (such as Brazil’s) and those where the case for outsized cuts was questionable (Poland). These divergent growth, inflation and policy paths are translating into more difficult market conditions, most GSM participants agreed.
Choppier Markets
The divergent global expansion is becoming a headwind for markets, depriving them of a clear narrative and direction. Meanwhile, incoming data aren’t providing enough clarity to anchor expectations, as suggested by a month when major asset prices lost ground across the board, except for oil and the dollar. Surprising strength in the U.S. added further pressure to nominal and real long-term yields, while also pushing the dollar higher. Within our investment-clock framework, the U.S.’s resilience is challenging the notion that its economy is gradually transitioning towards “reflation”—a regime of below-trend inflation and rate cuts—and, instead, suggests a more prolonged late-cycle environment of higher-for-longer rates. Unlike during previous months, cross-asset correlations increased in August as stocks sold off in tandem with bonds; EM local government debt, which had vastly outperformed developed-market bonds through July, also came under pressure, mirroring rising U.S. yields (see Figure 2).
Some GSM participants also flagged a potential shift in the market’s perception of spillovers from China. Whereas EM ex-China stocks outperformed the China index by double digits through July, the two buckets have moved more in line over the past month. Stocks worldwide came under pressure in August, and some participants pondered whether this apparent “recoupling” could mean that mounting fears over China’s economy are morphing into a more generalized headwind for risk. Uncertainty about DM long rates, the dollar and China—and expectations that it may persist for the near future—meant the GSM’s general tone was cautious, with speakers reiterating the importance of selectivity.
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