Despite rates increasing by about 500 basis points since the middle of last year in the US, the economy is “still resilient” with some “pockets of weaknesses here and there,” Nicolas Sopel, senior macro strategist at Quintet Private Bank told Delano last week. Sopel explained that it takes time for the “monetary policy tightening to impact the economy.”
No hard landing is expected by Quintet and it is forecasting that GDP will grow by 0.6% in 2023 which suggest a “shallow recession,” if any. Services have been “holding up the US economy,” said Sopel, but it is showing signs of weaknesses.
[Growth] could even take a bit longer in China” due to the “deep covid scars in Chinese society
The higher rates have had a higher impact on inflation which are currently standing “below 5% and trending lower,” from a level as high as 9.1% in mid-2022. Sopel expects the Fed rate to pause, after maybe a 25 bps hike in July, until the end of the year. Going further out in 2024, Sopel expects the Fed to cut rates should inflation goes back to “2%-3%,” even if it stays above targets. Importantly, Sopel thinks that the rates may decline earlier to “avoid that deep recession.”
Normalisation is finally arriving in Asia
Despite the impression by several market participants that China’s economy is currently sputtering as observed by the recent import-export numbers, Sopel expects growth to rather enjoy an “ongoing pickup.” As for Japan, which has seen positive development when releasing its Q1 GDP figures thanks to a normalisation in 2022, Sopel explained that normalisation takes time and “it could even take a bit longer in China” due to the “deep covid scars in Chinese society.”
Having worked in Singapore and still maintaining personal relations with the Asian continent, Sopel explained that people still wearing masks somehow shows a lack of confidence by the population. Also, the recent weak retail sales figure in April may be the result of some savings “ahead of very important holidays in May,” said Sopel. To support his point, Sopel noted that domestic tourism reached levels above 2019 in May.
Contrary to the west, “inflation is not an issue in Asia or in China,” said Sopel, a favourable situation that enables “governments or central banks [to] come up with some sort of monetary policy easing.”
Europe, the laggard for now
Inflation dynamics are slightly different in the US and Europe. As inflation is stickier in Europe than in the US, Quintet expects the ECB to hike rates by 25 bps, once or twice with an expected pause “at some point later in the year.”
Despite the hawkish wordings of European Central Bank’s president, Christine Lagarde, Sopel thinks that the ECB does not want to cause a “major recession” and that the recent rate hikes have had significant impact across the continent on various parts of the economy such as in real estate market while inflation figures have benefited from a decline in the price of energy.
Cautious stance on investments
Overall, Quintet tends to prefer high quality fixed income securities over equities given that the six months T-bills yield as much as the earning yield on companies (S&P 500). Moreover, declining growth coupled with peaking interest rates will favour treasuries and investment grade bonds over non-investment grade bonds.
The situation is a bit different in the European and UK investment grade markets, as Quintet expects them to experience some pricing pressure given that rates by the ECB and the BoE will further increase.
Quintet sees limited upside on stocks and would elect “defensive, low-volatility equities” to “mitigate downside risk while partially capturing the upside.” The same is true for the eurozone equities with Quintet being more specific by recommending a “higher weight on sectors like healthcare and consumer staples.”
Quintet has a “slight preference for equities in the Asia Pacific region” on the back of “resilient corporate profitability, improving economic growth, loose monetary policy and, following structural reforms, higher standards of corporate governance.” In addition, Asia benefits from a strongly integrated continent-wide supply chain that will benefit from the domestic rebound in China and offers an attractive relative value proposition compared to US equities.
Euro expected to strengthen
Quintet sees the US dollar as overvalued. It expects the pause at the Fed to result in a reduction of the interest rate differential dragging down “[the greenback] against the pound and euro toward 1.12-1.15” for the latter. In addition, Sopel believes that the growth differential will further support the eurozone over the US in the coming six months as “Europe will continue to be more resilient [than the market expects]” on the back of the return of Chinese tourists to the old continent and manufacturing nearshoring trends.
This article was published for the Delano Finance newsletter, the weekly source for financial news in Luxembourg. .