All eyes will be on the US Federal Reserve’s Federal Open Market Committee meeting this week, where the US central bank is expected to announce the start of the tapering of its asset purchase programme.
We anticipate that the Fed will formally announce the start of a tapering of its monthly asset purchase programme, which should end by mid-2022.
While this will signal the beginning of the end of ultra-loose monetary policy enacted due to the pandemic, Fed officials are expected to stress that the first interest rate hike is some distance away. With a gradual pace of exit from Quantitative Easing, or QE, we believe that conditions remain broadly supportive for risk assets. Moreover, the US 10-year real interest rate remains firmly in negative territory at around -1%, which will continue to be supportive of risk assets.
That said, we do expect the Fed to signal that the pickup in inflation has been more persistent than anticipated, due to factors such as supply chain disruptions and higher energy prices, and will likely keep inflation above its 2% target well into 2022.
The global upward pressures on prices have become a point of concern for other central banks. The Bank of Canada unexpectedly announced the end of its QE and brought forward the guidance on rate hikes last week, while the Bank of England looks set to raise interest rates by the end of the year.
Concerns over inflation have resulted in a bear flattening of the US Treasury yield curve with the US front-end rates moving higher as markets price in a more aggressive pace of rate hikes, while long-end rates drifted lower under the shadow of stagflationary concerns.
We believe that inflation will remain within a manageable range, given the Fed’s average inflation targeting framework, but caution that this remains a key tail risk for investors and needs to be monitored carefully.
Our forecast for inflation is consistent with an outlook for elevated prices in the US. Price increases in the key contributors so far this year such as cars and housing have been largely supply-driven. The tail risk is that we may see a spillover effect into further increases in services costs, wages, and consumers’ long-term inflation expectations. Core personal consumption expenditure (PCE) inflation came in at 3.6% Year-on-Year in the month of September, and we expect it to rise further into the end of this year to above 4%, before trending down towards the Fed’s target next year.
All considered, we see a moderately risk-on stance in our asset allocation strategy to be optimal. We continue to hold an overweight position in US equities, which we believe will benefit from a healthy corporate earnings outlook.
We are midway through the latest earnings season, where more than 50% of companies in US, Europe and Japan have reported their third-quarter earnings.
Earnings have been healthy, with all three markets delivering above-consensus performances, although by a smaller magnitude compared to the previous two quarters. Over 80% of US companies that have reported showed above expectations earnings per share (EPS). In Europe this was around 70%, and around 50% for Japanese companies. Earnings growth in 3Q21 remained high given the relatively easy comparables this time last year; EPS grew by ~34%, ~44% and ~27% for US, Europe, and Japan respectively.
On a market-weighted basis, ~64% of the S&P500 index beat estimates, underscoring the strength of the recovery of US consumers and the US economy. Notably, tech remained an earnings leader, with 100% of the information technology and communication services companies that have reported to-date showing above-consensus results.
Nonetheless we are watchful of how companies are dealing with the very same issues that are on the radar of policymakers, such as input costs, and the state of the labour market and global supply chains.
For instance, Apple CEO Tim Cook said that the ongoing supply constraints would negatively affect its 4Q21 performance, more than the USD6 billion hit to revenue that it saw in 3Q21.
Similarly, the management of Amazon guided next quarter’s earnings lower, noting that it expects to face additional costs (~USD4 billion) in costs related to labour and inflation in the upcoming peak holiday season as it continued to face labour shortages.
We continue to hold a neutral stance in Asia ex. Japan equities, particularly as the latest economic data from China reaffirm our view for near to medium term economic headwinds.
China’s latest official manufacturing Purchasing Managers’ Index (PMI) showed that manufacturing output continued to contract in October.
The index came in at a below-consensus reading of 49.2, below the threshold of 50 indicating growth, and lower than September’s reading of 49.6.
The sub-indices for output and new orders slid further while export orders showed a small uptick, suggesting that domestic demand continued to weaken, in contrast to external demand.
The continued power rationing and increases in input costs had been key drivers as well. China’s producer price index (PPI) reached the highest reading since 2016 of 61.1. The services PMI similarly moved lower, from 53.2 in September to 52.4 in October. The overall composite PMI therefore moved lower to 50.8 from 51.7 previously. The Chinese economy is clearly still slowing at the start of 4Q21.
The continued weakness is consistent with the muted picture of financial conditions in China. Total social financing (TSF) grew by 10% YoY for the month of September (versus 10.3% YoY in August), the slowest since 2006. The biggest contributors to the slowdown in credit growth came from consumer loans, especially in the medium- and long-term household loans, i.e. mortgages, reflecting the still-tight credit environment on the property sector.
Short-term household loans were growing slower as well. Corporate loans were also growing at a slower pace, despite an uptick in the short-term loans and commercial paper segment.
While China’s economic outlook appears subdued, we believe that the risk of significant economic downside, particularly in light of concerns of contagion from Evergrande’s debt issues, are contained.
Latest developments signal that policy makers are moving to manage expectations more strongly. For instance, during a press conference in mid-October, PBOC officials responded to market concerns on the impact of the recent turmoils of Evergrande in terms of potential spillovers to the property and banking sectors, and indicated that the spillovers to the wider financial sector were “controllable” and that it would urge property developers to fulfill their obligations on their offshore US-dollar denominated bonds.
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