Fed + China = A Positive Global 'Journey'

“Don’t stop believin’” ? ??????? Journey, Don’t stop believin’

Written by Neil Staines, 27th September 2024.

Last week, we discussed the surprise 50bp cut from the Federal Reserve at the September 18th policy meeting. Surprise in the sense that going into the meeting, markets were pricing an equal probability of a 25bp cut and a 50bp cut, so in that respect, anything they did would have been a surprise. However, we argued that the event was, in reality, a dovish pivot and that the Fed - and, by extension, other DM and global central banks, were just getting started - we argued that the actions of the Fed, in front-loading rate cuts and emphasising greater confidence in the controlled path of inflation likely, in turn increases the risk premium for an October rate cut from the ECB and even for a 50bp cut from the BoE in November.?

Importantly, the Fed statement emphasised the fact that the committee had “gained greater confidence that inflation is moving sustainably toward 2 percent” and that the “risks to achieving its employment and inflation goals are roughly in balance”. We have argued on a number of occasions that if the risks to both sides of the FOMC mandate (price stability and maximum employment) were moving into closer balance and Powell has emphasised the fact that the Fed would want to reduce the restrictiveness of monetary policy well ahead of reaching the 2.0% inflation target, then it could be argued that the Fed were already behind the curve. The 50bp last week has caught them up a little.

Livin’ in a Lonely World

Ultimately, we took a couple of thoughts away from the FOMC. Firstly, the actions and economic narrative from the Fed were entirely consistent with our now long-held macroeconomic thesis - Continued disinflation and growth moderation (but not recession), or what could be described as a soft landing. Powell’s commentary that “we don’t think we are behind” the curve but that “markets can take this as a sign of our commitment not to get behind”, further reinforces the dovish reaction function of the Fed - or the reinstatement of the ‘Fed Put’. This is very important, from our perspective, especially for risk assets.

On growth, the Fed narrative was also positive: “if you look at the growth and economic activity data, retail sales data we just got, second quarter GDP, all of this indicates an economy that is still growing at a solid pace”. Indeed, the SEP projections see growth holding steady, just below the equilibrium growth rate through the forecast horizon. OECD updated forecasts this week; however, project US growth is slowing from 2.6% in 2024 to 1.6% in 2025. Interestingly, they also project that eurozone growth will accelerate from 0.8% this year to 1.3% next year - a sharp narrowing of the Europe vs. US growth differential.

Up and down the boulevard

Having argued last week that the policy activism at the Fed was likely to increase the likelihood of both an October rate cut from the ECB and even a 50bp cut in November from the BoE (as the September MPC ‘hold’ - the day after the Fed - had already been voted on. As is the structure of the non-MPR month meetings), markets now see a 60% chance of an October rate cut from the ECB (vs. a 27% probability last week) and, although the very modest pricing of a 50bp cut in the UK remains little changed, we expect the fiscal tightening bias from the October UK Budget, as well as the materialisation of what we see as a weaker underlying demand trend in the UK as supportive of a more activist BoE.?

Some will win…

However, the big news this week was not in the US, Europe or the UK, but in China. After a protracted period of acute (and some might say self-inflicted) domestic demand weakness, this week brought a very significant policy pivot in two parts. After a wave of rumours, this week started with a raft of liquidity measures: from an RRR cut and a proposed reduction to existing mortgage rates to stock lending facilities using current stock holdings as collateral (or as part of a collateral swap) to facilitate buying more stock - among the measures. These measures were considered significant but likely insufficient at the time because liquidity without support for demand (and likely without addressing the weakness in the property market) is unlikely to alter the dial much.

However, the second set of announcements this week, this time from the Politburo, were in conjunction with liquidity measures, much more significant.? Specific aims of the announcement were (i) to improve the consumption structure, (ii) make efforts to boost capital markets, (iii) to strengthen support for college graduates, (iv) to implement ‘forceful’ interest rate cuts, (v) to strive to complete annual goals and perhaps most importantly (vi) ensure the necessary fiscal spending to achieve these aims.?

It is not clear that these measures will be a panacea to all the problems the Chinese economy has faced over recent years; however, this is clearly very significant from a liquidity and fiscal expansion perspective. At the global Macroeconomic level, perhaps more so!?

?The Long & Short of it...

With significant investment and supply chain crossovers, Germany is likely a key beneficiary of the positive progress in China. Indeed, from our perspective, the positive connotations for global growth and risk assets from a concurrent (i) Fed rate-cutting cycle and (ii) China stimulus are significant. We have argued for many months now that our macro configuration of disinflation and growth moderation is supportive of risk assets, duration and the USD. If we now add in the additional risk positive of a supported Chinese economy, then the prospects for risk assets and even Emerging Markets is increased. To paraphrase Journey, the data and events we have seen this week mean we don’t stop believing in risk assets. Indeed, with the combined stimulus of Fed rate cuts and Chinese stimulus, equities can ‘hold on to that feelin’ through the rest of 2024 and perhaps beyond.

What is happening next week?

Sources:

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