Market Commentary: US inflation and interest rates | China relaxes its Covid controls

22 December 2022
Stephanie Leung
CIO Office

Watch Stephanie Leung, Co-CIO, and Albert Kok, Deputy Country Manager, Malaysia, discuss the latest global events and their potential impact on the markets and on our investment portfolios.

In this episode:

  1. What does the latest US inflation data mean? [2:00]
  2. How markets reacted to the Fed’s 50bp rate hike  [04:46]
  3. How should investors be positioned for 2023? [07:34]
  4. The implications of China relaxing its Covid controls [10:46]
  5. Why we should stay invested ahead of a potential recession [20:38]

Albert | 00:02 

Hi, everybody. Thank you for waiting. We started a little bit late today because there were some technical issues on our side. But yeah, thank you all for joining today. We're back for our – I think this our fourth live market commentary that we're doing here. And this is where we talk about the latest developments in the market and share our thoughts on them. And today, as your host, I am Albert. I'm the deputy country manager in StashAway Malaysia. And we are joined today by Stephanie, who is our Co-Chief Investment Officer in StashAway itself. And this is a live event. If you have any questions based on what we talk about, do feel free to post them in the chat box on the site. And we will get back to you later on. How are you, Steph? It's been a while.

Stephanie | 00:51 

Yeah, I know lots of happenings in the markets and yeah, I'm in Hong Kong. Freezing cold today.

Albert | 00:59

Well, global warming, maybe. And I guess this year itself, it's almost at the year-end already and it's almost Christmas. So you know how time flies, right?

Stephanie | 01:11

I know.

Albert | 01:12 

Yeah. This year, 2022, pretty much has been an eventful year with many things happening. And we will actually be doing a market outlook come January next year. So do keep an eye on that when we post the dates for that event. However, for today's session itself, this is where we look at current market conditions. I would like to focus on two things. Firstly, being about the US and the second one about China itself. We seem to be talking a lot about these two things and the past few webinars, but we do this for a good reason because they are the key drivers. So starting off first with the US itself, right last night, we have had the Fed raise interest rates by 50 basis points. We also had on Tuesday itself economic numbers, in particular the inflation figures coming out, which came below expectations. So would you be able to share your thoughts on this? What are the implications on this, on the economy?

Stephanie | 02:22 

Yeah, I guess I mean, the data and also the Fed has been keeping all of us quite busy even though we're entering the last month of the year. So on Wednesday, sorry, on Tuesday we got the CPI number. So the market actually rallied on the number because actually if you look at CPI, the numbers actually came in below expectations both on headline as well as core. So headline numbers came in 7.1% year-on-year and consensus was actually looking for around 7.2 to 7.3%. So below consensus was a good news. Also, if you look at the kind of trend of the CPI, it has started to roll over. So if you look at the peak, CPI was maybe in June, that was about 8.5%. But if you look at the three month moving average, even the six month moving average, I mean, they have actually been trending lower. So the three month and six month moving average are kind of what the Fed really watches quite closely because one month doesn't make a trend. But when you have the six month sort of term, I think that sends a strong signal that inflation is coming off. If you look at the month-on-month increase, it came in at 0.1% and 0.1% is of course very, very close to zero.

Stephanie | 03:41 

And just a few months ago, we were seeing month-on-month increasing at a pace of 1%. So, I mean, this is a very, very significant slowdown in terms of inflation in the US in particular. If you look at kind of the components of the CPI, what the Fed focuses a lot on is of course the service inflation ex-housing, because this is where kind of the labour market would have an effect and this is where the part which is most sticky. So because if you look at housing, housing has already started to roll over, even though it doesn't show up on the CPI yet. But there are some more real time indicators that you can look at. I think we mentioned a few last time, so those have rolled over already. So the market actually took the CPI news as a piece of good news because like if you look at the way the bond market is pricing in, basically the market is saying that CPI will get to 2.5% in about eight months’ time. And that is very, very close to the Fed's target of 2% or 2 to 3%. So there's a lot of hope that, oh, maybe the Fed will actually put on the brakes and slow down.

Stephanie | 04:46  

And in fact, during yesterday's FOMC meeting, the Fed actually raised interest rates by 50 basis points. And in the past four hikes, the Fed actually had been keeping at 75 basis points. So 50 basis points is actually a slowdown from the previous. Which has been historically very, very quick. However, the market actually, I guess, sold off on the FOMC meeting because of two things, I think. Number one is the 50 basis point hike was actually very well telegraphed and the market was actually expecting a 50 basis point hike. And Powell has said that they will do 50 and the CPI coming off didn't actually make them, I guess more dovish. So, for example, in in the press conference that followed, Powell basically maintained a very, very hawkish stance or he basically stated that the Fed would still be very resolute in keeping a tight monetary stance in order to make sure that they don't repeat the mistake that the Fed did in the seventies, which if you remember in the seventies, actually we had double peak inflation. So inflation originally came off, but then the Fed actually let go of the brakes too soon and inflation started to pick up again. So Powell, given his mandate of getting inflation down, I mean, definitely has studied history and doesn't want to repeat that mistake again.

Stephanie | 06:12 

So he was actually quite hawkish and particularly when he saw risky assets rallying. He didn't – I guess he wanted to put a lid on the animal spirits because that is kind of what causes very sticky inflation. So, unfortunately, Powell had to deliver a more, I guess, hawkish message to prevent the stock markets and interest rate markets from rallying. And, of course, I mean, the next few meetings will also still be quite key. And I think Powell will be paying close attention to data in coming months. I think if you look at the Fed's composition, actually there will be more dovish voting members being added next year, which actually in a certain way makes Powell more likely to stay hawkish because he needs to take the lead in terms of the Fed actually maintaining their tight monetary stance to actually reset inflation target. So yeah, it's kind of ice and fire. So you had good news on one day and then bad news the other day. So it kind of just did a round trip.

Albert | 07:34 

And with the Fed Chairman Powell being so focused on getting inflation rate down to 2%, which is the supposed target neutral rate itself, we still have a long way to go. So that means interest rates are going to be higher for longer. A lot of talks have been about potential recession coming in next year itself in 2023. So how should one be positioned for such an environment?

Stephanie | 08:02 

Yeah, so the reason why the bond market is saying, oh, inflation is going to come off a lot. And also the Fed will have to cut interest rates because the bond market is also expecting a very sharp slowdown in economic growth. And I mean, given the pace that we've had in terms of monetary tightening, I think if you look at some of the indicators, including those that we track, it’s actually slowing down very quickly in terms of economic activities. And quite likely we're going to see a sharp slowdown and possibly a recession early next year. I think in this environment, of course, the bond-equity relationship has not been negative in the past 12 months because the Fed was actually tightening. So if you hold a diversified portfolio, unfortunately, both stocks and bonds actually went down. So the protective part of the portfolio actually didn't perform as expected. However, as economic growth starts to slow down, I think the protective nature of bonds would actually start to come back as investors need to find safe havens. And also, if you look at the static view of bonds, right, right now with Fed funds at such a high number compared to just 12 months ago, as an investor in fixed income, you're actually getting very, very good yield to start with. So I do think that over the course of the next few months or even next year when economic growth starts to slow, you see kind of bonds performing or fixed income assets performing as they should have in a kind of tricky environment. So again, it's back to having a more balanced portfolio of equities, bonds, gold and other asset classes to weather through the potential recession that we're going to see in the next few months.

Albert | 10:00 

To just pick the question here out of the crowd, because they are something relating to what we're talking about. And the question is from Mark itself. He's asking, are we expecting that there'll be another rate increase after this recent 50 basis point increase with the expectation that there’s potentially a recession coming along?

Stephanie | 10:21 

Yeah. So, I mean, the Fed wants to get interest rates above 5%. So, I mean, we do expect further interest rate hikes. But the pace is going to slow down. And whether the next hike is 50 basis points or 25 basis points really depends on the data. So, I mean, that's why at StashAway we pay so much attention to incoming data to help us to kind of navigate these markets, because that's what the Fed is watching as well.

Albert | 10:46 

Okay. I guess switching gears a little bit to China itself. One of the big news that came out of China in November was the I guess not big news, but multiple big news was the relaxation of COVID controls there. And we saw new guidelines being issued, relaxed testing for locals moving around, even relaxed travel requirements. And more recently, we even saw China stop releasing that data, the comprehensive data on new COVID cases. And they say that they’ll only report symptomatic cases from now on. So the question here is that given the relaxation, can you share more about the credibility of these moves? Because as China opens up, naturally cases will rise. And will they be forced to U-turn on their own policy? Taking note that yesterday, the retail sales in China came down below expectations, it was down about 6% for the month of November. So yeah, what do you think about that?

Stephanie | 11:51 

Yeah, I think if you look at China's economy, it has been slowing down very, very quickly and slowing down for quite some time already, particularly with it's two growth pillars, I guess, affected by anti-monopoly campaigns being the Internet sector and also the property sector. So, I mean, those two are very, very important growth engines for China. And with the economy actually being shut down by COVID restrictions, I mean, that actually that definitely doesn't help in terms of economic growth for China. And I think if you look at kind of the announcements over the past few weeks, it's been quite drastic. So more than half of the COVID restrictions have actually been reversed. Actually, a Bloomberg estimate says 60% of the economy is now open. Now, of course, 60% is an improvement, but it's still far below what the rest of the world is, particularly with respect to international travel. And that also affects quite a bit of how I mean, foreigners can conduct business in China. And also Chinese can conduct business outside of China. So, I mean, that remains a very, very key, thing to watch is, when would China start to relax its international travel policy in terms of, I guess, the economic impact? I think it's definitely a good gesture, a good sign. And I mean, back a few months ago when we were talking about our view on China, we said there's two things that we would monitor for a sustainable China kind of risky asset recovery. Number one is the COVID reopening. Second is economic recovery. So we've seen progress in the first part. We haven't seen progress on the second part yet. And if you look at the PMI data, for example, it’s still slowing down.

Stephanie | 13:42 

Retail sales, as Albert mentioned, are still very bleak. I think because of the seasonality right now. So China is actually going through winter. It's very, very cold. And just given a lifting of restrictions, that's going to be a lot of cases. And in fact, I mean, there are some models that show over the next two weeks we're going to see a peak in terms of COVID waves in most of China. So China needs to actually get through these, I guess, these waves. And it appears inevitably when you have COVID waves, it affects productivity of the country. And then also you have Chinese New Year in kind of mid to late Jan as well. And that is another litmus test of the COVID situation because you have people traveling, carrying COVID across the country. So that is another big test. So I think for the lifting of COVID restrictions to be able to filter through to the real economy, it would have to be kind of later in the first quarter, i.e. after Chinese New Year or when the weather actually gets warmer because there's actually a lot of money, liquidity being pumped into a system that is not being used because of COVID restrictions. If you look at the chart and the policy, that's definitely a positive, positive development. But I think we need to see kind of affirmative data to show that there is actually turning around of the economy. I guess, in Hong Kong, I mean, we actually can feel it quite, quite quickly, the relaxation of the restrictions. So, yeah, we'll be reporting in real time.

Albert | 15:29 

Right? Yeah. Based on what Steph just mentioned, you have questions relating to China itself. Feel free to post them. But what I like to carry on from there is that the reopening cases are likely to rise. More people could get sick. The economy could be affected locally. And as we enter Chinese New Year itself slash winter, things are expected to slow down. So what implications does this have in terms of global growth and also inflation? Right. Because when China opens up, consumption is expected to increase, driving up inflation. And then it's also countered by the effect that more COVID cases could reduce productivity. So what do you think about that?

Stephanie | 16:14 

Yeah, I think the impact would be clearer towards the end of the first quarter and maybe throughout next year, given that, I mean, China is of course, a very, very big economic bloc, and the fact that China has been shut down for a year has negative impact on inflation. I mean, oil prices would be trading maybe $10 higher if China is not restricted by COVID. So when China actually can reopen fully, I think that provides some support to energy prices and commodity prices. Of course, that is offset by the slowing down in the US. So you have to kind of think in three dimensional terms and how different kinds of forces impact oil prices. And oil prices, of course, very, very important driver of global inflation. So net-net, I mean, the China reopening would be supportive of higher oil prices, but it's also tempered by kind of slowing growth in the US, which then brings us to a very, very interesting dynamic because it would be the reverse of like 2022 and or arguably later part of 2021 when the US is very strong. China is kind of going through an economic slump next year that may reverse. And of course that has implications for global growth and how you position.

Albert | 17:34 

On that point, I got a question also from the audience. You're asking that given that China’s COVID policy has shaken many foreign investors, their faith in China itself. So with this lifting of restrictions, would that help the Chinese market in terms of attracting new foreign investment, or will they still be cautious? I think what's my thoughts adding on to this is also we have the news that the US came out by adding a few companies to the so-called sanctions list itself. So what do you think about it?

Stephanie | 18:05 

Yeah. So I think if you think about China, you need to think about two forces – structural forces and cyclical forces. So COVID is a cyclical force that goes in cycles, the economy, liquidity, these are kind of cyclical forces. The structural force that will be in place for quite some time is the kind of changing of the US-China relationship. So before I guess we followed a trade war before COVID, we had a more globally linked economy, i.e. China has been working closely with the US. I mean, there's a lot of trade, a lot of cooperation, COVID development going on. However, this trend has changed in the past few years. And going forward, it's very, very hard to see this trend reverse, i.e., there will be a bipolar world where China will go its way and the US will go its way. So this is a structural force that wouldn't change. And I think, of course, if you look at the semiconductor industry, for example, the US is trying to limit what China can import from the US and its allies in terms of, for example, advanced technology. And if you look at some of this, the chips or the technology that they're trying to prevent, it'll slow down China.

Stephanie | 19:25 

But I think for some of the, for example, in terms of military that doesn't use very, very cutting edge AI chips, that has not a lot of impact. But going back to the cyclical side, I do think that given the kind of potential reversal in China's relative economic performance versus the US, we can see China and emerging markets being more attractive to investors in the next year. Now, having said that, of course, Chinese stocks have rallied quite a bit, almost 30% in the past few weeks due to COVID reopening, and that was actually a bounce from a very, very low level. If you look at the price to earnings ratio, how expensive is MSCI China, for example? It was at eight times, nine times like a few weeks ago. Now it came back to 11 times or so, which is kind of the historical average. So I think for Chinese assets or for Chinese equities to have more upside, we do need to see sustained earnings recovery. And that really depends on, for example, PMI starting up and expanding, the economy coming back to life.

Albert | 20:38 

Okay. And I guess just the final question for today, we circle back to what we talked about earlier about recession. And given the expectation of a slowdown and a recession coming, why should we stay invested in funds itself or even StashAway’s funds, right? Should we just pull out and just wait at the sidelines? And when can we expect the recovery?

Stephanie | 21:04 

Yeah, that's a great question. Of course, the probability for a recession is very high. But I mean, it's also number one, it's also a probability. Right? Secondly, I think if you look at how risky assets perform, typically stocks or risky assets bottom before the economy does and also with a lead of a few months. Thirdly, if you have a more balanced portfolio, for example, with equities and bonds and gold, etc., you can actually weather through a recession with lower volatility. So because the bonds would be supportive of the portfolio. So then you don't have to worry about trading in and out because I mean, frankly speaking, it's very, very hard to kind of trade in and out according to what the market is doing or what the latest headline is. So the best way to do it is actually to stay invested in the long term. And also, I mean, when the market is down is a good time to actually use dollar cost averaging too, if you have spare cash. I mean, those are good opportunities to actually add to your portfolio.

Albert | 22:18 

All right. And there you have it from Stephanie. Thank you so much. This is you know, this is the end of the session. If you have any more questions on what we talked about, please feel free to reach out to As I mentioned earlier, we will be doing a market outlook event come January. So you can keep an eye on when that's happening. Yeah. Thank you so much again Stephanie for sharing your views with us. Thank you to all the audience for dialing in tonight. I hope you all have a good day and do take care.

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