The month of March marked continued concerns about the hawkish stance adopted by the Fed in tightening its monetary policy as the bond market bore the full brunt of it. The global equity market was more hesitant in this respect as shown in the volatility of its performances. We shall first take a deeper look at what this means in terms of the monetary policy tightening and its effects on the financial markets.
The Fed has confirmed that they would begin reducing the central bank balance sheet by US$95 billion a month, likely beginning in May. In addition, the pace of interest rate hike path will be more aggressive. We believe the financial market is looking nervously at how the monetary policy would move expeditiously towards a neutral stance. The neutral level is a theoretical position where it neither speeds up nor slow down economic activity. The key will be the impact on the job market and broad economy as rates jump higher and growth slows. It’s a signal that the economy is headed for an economic slowdown or a possible recession, though the inverted yield curve does not predict exactly when it will happen, and history shows it could be more than a year away or longer. So far, the bond market has been suggesting that a sharp economic slowdown would eventuate from this hawkish Fed guidance, as demand destruction becomes a real risk. It is difficult to forecast this possibility at this stage as the other counter-balancing forces in the form of border reopening, higher economic activity, and better corporate earnings have so far been favourable. Of the 89 companies in the S&P 500 that have reported first-quarter results, 78% have beaten earnings estimates, according to Bloomberg Intelligence.
In our view, global inflation shall remain high given that the global economy is chugging along with the exception of China, deglobalization is taking place and the supply chain bottlenecks have not been eradicated. This does not mean the global economy would not grow strongly. We remain confident, in particular, of a surge in technological adoption, with sizeable impact. The resurgence of inflation, which is eating into profit margins of companies, is also likely to spur more restructuring and labour-saving equipment that can help in productivity growth.
In the short-term, authorities in China again signalled they intend to loosen monetary policy to alleviate the impact of an escalating Covid-19 outbreak and slumping property market. It is also an acknowledgement that domestic and global risks are now bigger than previously expected. There were also signs that top financial leaders have talked about easing regulatory crackdowns, a good development. We expect fiscal policy to do the heavy lifting. So far, corporate income tax for small firms will be lowered to just 5%, while the government spending is set to be higher compared with last year.
Although Shenzhen and Shanghai have seen lockdowns, there are signs the Chinese government is altering its way of controlling the pandemic while allowing some form of economic activity to continue. In any case, from past resurgence of infections in various countries, this negative impact would prove to be short-lived and limited.
In the long-term, as the major countries’ interest are at odds with each other, the global trade growth would be lower as more points of friction would emerge and the world is more unsettled. Countries around the world would likely resort to inward-looking policies to promote domestic production over imports. This is to increase the level of safety and security at every level of the country for self-sufficiency.