Text on screen: Stephen Chang, Portfolio Manager, Asia
Text on screen: What are the key takeaways from our latest cyclical outlook?
Chang: Much of the global economy has transitioned quickly from an early cycle recovery to a mid-cycle expansion, necessitating a faster policy shift from the extraordinarily easy conditions that prevailed in 2020 and 2021, in our view. As such, monetary policy in most regions has shifted course toward normalization.
Further complicating matters, the speed of the recovery coupled with the volatile path of the virus have contributed to more significant frictions in both goods and labour markets that have elevated inflation. The timing and extent to which these issues resolve and inflation moderates is highly uncertain, raising the risk of an unwanted jump in longer-term inflation expectations – an outcome that we expect central banks will want to avoid or mitigate. Our base case has global inflation peaking by the first quarter and then moderating closer to central bank targets by the end of 2022, and we are closely monitoring upside risks to that view.
Overall, the broad contours of our 2022 outlook suggest above-trend (albeit slowing) growth and moderating inflation prompting a still gradual tightening in developed market monetary conditions. Nevertheless, we see three important risks to our base case, which create a generally more uncertain environment for investors: First is that inflation remains persistently elevated; Second, that variants drive surges in COVID, which restrict activity and spur more inflationary pressures; and finally, that financial conditions tighten more abruptly than expected.
Text on screen: Key Takeaways from our latest Cyclical Outlook
- Monetary policy in most regions has shifted course toward normalization, as global economy transitioned from an early cycle recovery to mid-cycle expansion.
- Our base case has global inflation peaking by Q1, then moderating closer to central bank targets by the end of 2022.
- Three risks to our base case:
- Inflation remains persistently elevated;
- Variants drive surges in COVID, which restrict activity and spur more inflationary pressures;
- Financial conditions tighten more abruptly than expected
Risk premiums and yields don’t currently reflect potential downside scenarios, in our view, which warrants caution and a rigorous approach to portfolio construction.
Text on screen: What are our expectations for China?
Chang: The COVID outbreak in Xi’an has triggered strict lockdowns in the city since December and we expect more cities could face similar challenges as China pursues its efficient and dynamic zero-COVID policy when cases arise.
However, the macro environment is now worse than Q1 last year, with energy constraints and the property market weighing on growth, while exports are expected to moderate in coming quarters due to the high base and softening external demand for manufactured goods.
Going forward, the property sector and risk of disruptions from COVID outbreaks will remain the key headwinds, while policy adjustment and support may potentially exceed market expectations. Much of the recent economic slowdown is policy-driven, given the government felt there was some cushion based on last year’s growth figures to push forward its long-term agenda, including de-carbonization, deleveraging, and common prosperity. While the reforms are unlikely to reverse course, we believe the near-term policy will focus on correcting any over-tightening.
On the property market, measures have been taken, including high-level guidance for banks to support reasonable funding to developers, normalization of mortgage loan extensions, and adjustments in transaction restrictions and mortgage rates at the city level. However, it will take a while for funding conditions to fully normalize and market sentiment to recover. We expect the property market to remain weak in the first quarter, before starting to improve as the year progresses.
Text on screen: What are the investment implications?
Chang: We believe multiple factors have the potential to influence the investment outlook, in particular the speed, depth, and evolution of central bank efforts to reduce their extraordinary monetary accommodation.
We plan to focus on the volatility that can result from the rapid pace at which the economic cycle is moving toward late-cycle dynamics, especially when some markets appear priced for a blue sky scenario where central banks achieve the elusive soft landing without substantial amounts of rate hikes. Yet, history reminds us that risks can arise when monetary policy pivots. We seek to increase the liquidity and flexibility of our portfolios to pursue opportunities as they arrive.
In Asia, we expect to take currency positions based more on intra-regional pairings given that the US dollar will be driven largely by the Fed’s actions. Our focus will be on monetary policy actions and relative valuations. In terms of credit, we expect the China property segment to remain quite volatile and specific credit performance to continue to diverge as companies navigate their debt maturity profiles and pace of balance sheet de-risking. India and Indonesia credits could see valuations further increase as they become destinations with a steadier risk profile for Asia credit investors.
Text on screen: Investment Implications in Asia
- Currencies: Take positions based more on intra-regional pairing
- Credit: China property segment to remain volatile; specific credit performance to continue to diverge
- Country spotlight: India and Indonesia credits could see valuations further increase
Overall, we continue to believe that active management is especially important during this fast-moving cycle where dislocations will happen and capturing resulting opportunities can be key to producing alpha.