When Giants Move: The Implications of aggressive policy easing in the US and China

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Investors and asset managers must contemplate the spillover effects and reverberations that will materialize across economies and markets due to the aggressive monetary policy easing by the giant central banks, the US Federal Reserve (Fed) and the People's Bank of China (PBOC), in a non-recessionary environment. Their actions will accelerate the global easing cycle and give a second life to inflationary pressures, which will build up and resurface in the not-too-distant future, forcing central banks to reverse course. This, however, is a story for another time. For now, the giant central banks' actions will lift markets.

There are a few giants in central banking. The most influential central banks regulate large economies and have a significant impact not only on their economies but also on regional or even global economies and financial markets, as in the case of the US Fed.

As such, the most influential central bank is undoubtedly the US Federal Reserve (Fed) and, increasingly, China's People's Bank of China (PBoC). Others include the European Central Bank (ECB) for the Euro area and the Bank of Japan (BoJ).

Since the US Federal Reserve (Fed) oversees the world’s largest economy and plays a critical role in influencing the value of the U.S. dollar, the most widely used reserve currency globally, its decisions have far-reaching effects. Changes made by the Fed, such as adjustments to interest rates or monetary policy, impact global financial markets, trade, capital flows and the global financial cycle. China is the world’s second-largest economy, and the PBoC plays a central role in shaping China’s economic policies, particularly regarding currency management and capital controls.

The aggressive easing actions recently announced by several central banks, especially from the US, suggest that either central banks know something we do not, or they have become hyper-sensitive to market pricing of growth, inflation, and policy, or are considering political and geopolitical factors. This hyper-sensitivity creates an overreliance on policy, preventing consumers and businesses from naturally and necessarily learning and adapting to economic challenges. As such, in the long term, it ultimately weakens the resilience and ability of economic actors to function optimally, potentially undermining long-term growth and stability. Consequently, the risks of zombification multiply.

Although many central banks worldwide claim policy independence, they lack much of it and tend to follow the US lead. US monetary policy actions can trigger a wave of similar actions across the global central banking community. As the monetary policy-induced growth stimulus becomes global, strong tailwinds will support asset prices. However, such actions in a non-recessionary environment will also trigger inflationary pressures.

This time, however, inflation will likely resurface faster than in prior easing cycles, given secular inflationary factors and the geopolitical backdrop, which suggests continued fragmentation and a move toward ideologically aligned trading blocs. In such a scenario, governments may do everything to protect and support their economies under the guise of ‘national economic security.’ In such a global environment, the movement of labor, commodities, and goods in general can come under strain, disruption, or change, contributing to inflationary pressures. However, this is not a business cycle phenomenon but a secular cycle phenomenon.

Regarding secular inflationary factors, we believe the world entered a new secular inflation cycle around 2015–2017, a topic we covered extensively in 2022. We opined that two inflationary trends are in play: one linked to the business cycle and one to the secular cycle. We expected business cycle inflation to fade somewhat, but we should not declare it ‘game over’ on inflation as though central banks have achieved victory. Instead, we should expect inflation to resurface readily, mainly due to a long list of secular variables.

The implications of when giants move in this context are that not only does growth get a tailwind, but so do risk assets, especially in the short term. However, eventually, inflationary pressures also receive tailwinds. As such, the current pricing of monetary policy expectations for the US Fed is incorrect and needs adjustment and recalibration. Unfortunately, the market's perception and confidence in the US central bank will also undergo recalibration.

The erosion of central bank credibility is a more significant and severe issue that can trigger a rise in inflation expectations. If inflation expectations become unanchored and business confidence erodes, the yield curve would experience persistent bear steepening, and markets would face higher volatility.

The new, post-unbridled globalization world with multiple secular inflationary forces suggests that the US and other large economies are now operating at a higher neutral rate. As such, central banks need to cut rates with much more caution and care. The last thing a central bank needs is an erosion of trust and a confidence crisis due to policy inconsistency or policies that are too sensitive to market pricing and sentiment. Therefore, we believe the US Federal Reserve's aggressively easing policy and creating liquidity in a non-recessionary environment is inconsistent with the business and secular cycles.

When giants move, there is an immediate, short-term, and long-lasting spillover. Actions taken by the central bank giants—the US Federal Reserve and China’s People’s Bank of China—will have large implications across the globe, both positive and negative. For now, barring any major geopolitical or political disturbance, markets should experience a resumption of asset price inflation in the short term. Inflation will follow, but that’s likely a story for the second half of 2025.

Enjoy the liquidity party while it lasts.

Notes, References and Charts

Chart 1 – Inflation a historical look, 1930 – 2023.? Inflation can not move lower and stay low in perpetuity.? The world has changed, and we are in new secular inflation.

Chart 1a. Fed cut the policy rate by 50bp while GDP was at 3% for Q2!? The US Fed’s main policy tool is the federal funds rate, which is the interest rate charged by banks to borrow from each other overnight. The Federal Reserve influences this rate through monetary policy decisions.

Source: www.federalreserve.gov

2. China Stock Market Rally Continues. Main Index Performance Comparison, September 30, 2024 (image source SSE.com)

For September, the CSI300 is up about 23%, CH50 21%, and Shanghai Composite +19%.

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3. China’s central bank, the People’s Bank of China, announced several supportive measures last week:

?a)????? Cut to the reserve requirement ratio (RRR) of 50bp with possible additional cuts between 25-50bp later this year.

b)????? Cut in the 7-day reverse repurchase rate from 1.7% to 1.5%

c)????? Cut in the medium-term loan facility rate from 2.30% to 2.0%

d)???? Cut to rates on existing mortgages by 50bp.

e)????? Cut the down payment required on second homes from 25% to 15%

f)?????? Increase in funding support ratio for housing re-lending program from 60% to 100%

g)????? Allocation of RMB800 billion for preferential lending to support stock purchases and buybacks.

h) Stock market - China encourages medium, long-term capital to enter the market with new guidelines.? https://english.sse.com.cn/news/newsrelease/voice/c/c_20240927_10762487.shtml

4. BIS Annual Report 2024 - https://www.bis.org/publ/arpdf/ar2024e.pdf