Hard Landing? No Landing? How Should I Land?

Market Narrative Changes: Stronger Growth and Stickier Inflation

The macro-economic outlook has improved globally, as reflected by recent data in the past weeks. US non-farm payroll figures were better than expected, US unemployment rate dropped to 3.4% (the lowest since 1969), and retail sales illustrated the still resilient US consumer. In fact, while savings have been run down, the consumer has been tapping credit card spending.

In the short term, this has helped offset any hit from inflation. However, how this would progress during the year is crucial. Furthermore, while US CPI figures were in line with forecasts, PPI figures were ahead, reflecting the challenge that the Federal Reserve faces. Nevertheless, those bears in the hard landing camp at best have been deferred.

European PMIs also beat expectations, and so did inflation in some major Eurozone countries. Therefore, the market narrative has changed in February. Inflation has proved to be stickier than expected and incoming data was stronger than expected. Expectations for higher policy rates have therefore heightened, causing bond yields to rise with US 10-year yields hitting 4%.

Moderate Upward Revision of Rate and Growth Forecasts

With sticky inflation, stronger-than-expected growth and resilient consumption, we have moderately revised upwards our estimates for the Fed’s and ECB’s terminal rates by one hike of 25bps. We now expect the Fed to end its cycle at 5.25% in May and the ECB at 3.5% (deposit rate) in June. We do not expect rate cuts this year from either central bank. Again, we repeat the same message we conveyed at the beginning of the year – Pause not Pivot in 2023.

Our 12-month forecasts of 2-year US Treasury yield of 4.0% and 10-year of 3.5% remain unchanged. In fact, surprisingly, the 10-year yields briefly went below our 12-month forecasts, falling to 3.4% in January.

We expect continued yield volatility given the evolving growth and inflation outlook. However, yield sell-offs should be gradually bought. Bonds are back, disinflation is the longer-term trend, and monetary policy acts with long lags. Nonetheless, central banks will not hit their inflation targets until 2024. It is a process, not an event. Labour shortage and job openings in the service industry remain robust. In addition, we have revised our GDP growth forecast for the US from 0.3% to 0.7% for 2023, and from -0.2% to 0.2% for 2024.

Income Opportunities amid Market Volatility

Indeed, there is no clear visibility on whether the US economy will be heading for a soft landing, a recession, or even a no-landing scenario. Market volatility has been rising as the market tries to interpret future Fed rates from economic data released every day.

The recent rise in yields provides a better entry point for adding to quality investment grade bonds, and a chance to extend to medium-term duration. There are also income opportunities from income funds, structured products (to monetise the higher volatility), Asian REITs and high-dividend stocks. 

Read Investment Navigator February 2023:  Chinese Equities to Bounce Further in the Year of the Rabbit?

China Data Beats Consensus Forecasts

China’s aggregate PMI rose to a 14-month high of 52.4 in February. The China NBS manufacturing PMI climbed to 52.6 from 50.1, while the non-manufacturing index also rose to 56.3 from 54.4. There was a pickup in both the construction and the service sectors. We have been bullish ahead of consensus on a rebound of China growth, and the figures from February were encouraging.

So far in 2023, China has been the only major economy easing both monetary policy and fiscal policy. It is in a very different part of the economic cycle than the rest of the major economies globally. Investors can consider continuing to “buy the dips” in China equities.

Conclusion

The market has shifted from a consensus (not including ourselves) hard landing fear in November to a “no landing” view in February on the back of better growth and stickier inflation. This provides opportunities to add positions in fixed income, as monetary policy acts with a lag and yields should be lower in one year’s time. Yields on US Treasuries and investment grade corporates are at multi-decade highs.

There are also income opportunities from income funds, structured products (to monetise the higher volatility), Asian REITs and high-dividend stocks.

We took a view opposite to the “hard landing fear” by upgrading China and Europe equities to overweight last year. These markets had rebounded by 50% and 30% respectively from their lows. Chinese and European data continues to surprise to the upside. We remain buyers of non-US equities including China on pullbacks.

CIO Asset Allocation March 2023