US Federal Reserve preview: trapped between a rock and a hard place

Summary:

A 50bp hike is widely expected given high inflation and a tight jobs market, but the market is pricing in a recession, and falling Treasury yields and a weakening dollar are undermining the Fed’s efforts to dampen price pressures. A hawkish Fed message will likely fall on deaf ears unless the data start proving the central bank right.

A step down to a higher peak

A 50bp hike at the 14 December Federal Open Market Committee (FOMC) meeting is the strong call from both financial markets and economists. After implementing 375bp of rate hikes since March, including consecutive 75bp moves at the previous four meetings, Federal Reserve officials are of the view that they’ve made “substantial progress” on tightening policy so it is time to “step down” to lower increments. Nonetheless, Fed Chair Jerome Powell and the team have been at pains to point out that despite smaller individual steps, the “ultimate level of rates will need to be somewhat higher than thought at the time of the September meeting”.

Scenarios for the 14 December FOMC meeting

US Federal Reserve preview: trapped between a rock and a hard place_1

Signalling could fall on deaf ears

In this regard, the Fed will be concerned by the recent steep falls in Treasury yields and the dollar, coupled with a narrowing of credit spreads, which are loosening financial conditions – the exact opposite of what the Fed wants to see as it battles to get inflation lower.

These moves were themselves triggered by a weak core CPI print for October that came in at 0.3% month-on-month versus a 0.5% consensus expectation, while the Fed’s favoured measure of inflation – the core personal consumer expenditure deflator – was even softer, rising just 0.2%. The market reaction seems excessive to us given this is just one month of data, annual core inflation is still running at triple the target, and to hit 2% year-on-year the month-on-month readings need to average 0.17% over time – and we aren’t there yet. The Federal Reserve will need to see several months of core inflation readings of 0.1% or 0.2% to be confident that inflation is on its way back to target and this is likely to be a key plank of its messaging.

With that in mind, we think the Fed is not finished with its rate hikes and its new forecasts will indeed indicate a higher path for the Fed funds rate to 5% with potential slight upward revisions to near-term GDP, and persistently high inflation forecasts used to justify this. Certainly, the consumer sector has been holding up better than many – including ourselves – expected, with strong jobs and income gains supporting spending.

ING's expectation for what the Fed will predict

US Federal Reserve preview: trapped between a rock and a hard place_2

Looking further ahead, several officials such as James Bullard and John Williams have suggested the Fed may not be in a position to cut interest rates until 2024, and we suspect Powell and the forecasts will echo this sentiment. However, we strongly suspect that this is more tied to the Fed trying to get longer-dated Treasury yields higher rather than a conviction call that recession and lower inflation over the medium-term will be avoided.

Inflation makes things tricky

Now, it is important to remember we get November inflation on 13 December – the day before the FOMC meeting – and the outcome will be important for what the Fed has to say. If core CPI comes in at or above the 0.3%MoM consensus forecast, its messaging as outlined above will probably prevail. If inflation is softer and yields tumble further then the Fed may have to be more forceful and perhaps raise the possibility of accelerating a run-down in the size of its balance sheet via reduced reinvestment of proceeds from maturing assets. The central bank will stick with the hawkish messaging until it is confident inflation is beaten.

5% in the first quarter but rate cuts from the third

In terms of our view, we look for a final 50bp hike in February, taking the Fed funds ceiling to 5%. But like the market, we think a recession will dampen price pressures and the composition of the US inflation basket, which is heavily weighted to shelter and vehicles, will facilitate a far faster drop in annual inflation readings than elsewhere. Remember too that the Fed has a dual mandate which includes an employment dynamic. This offers the Fed greater flexibility versus other central banks to respond with stimulus and we believe it will from the third quarter of 2023 onwards.

Market rates have dropped like a stone – time for the Fed to sell bonds?

If the Fed wants to re-tighten financial conditions by enough, it needs to engineer a hawkish hike. Longer dates, in the wake of the recent falls in yields, are trading as if the Fed is done post the December hike. Assuming the Fed is not done, the first quarter of 2023 should sustain a rising rates theme to it. That should force yields back up, commencing a dis-inversion process on a curve that is now heavily inverted. We’ve likely seen the peak in market rates, but that does not prevent market rates from moving higher, at least for as long as the Fed is still hiking and the end-game is not fully clear.

The Fed has not said too much about the circumstances on the money markets. We still have in excess of $2tr going back to the Fed on the reverse repo facility, reflecting an excess of liquidity in the system. This in turn is driven there as a counterpart to the volume of bonds still sitting on the Fed’s balance sheet. The Fed is rolling off some $95tr per month, but there is always the option to do more, or more pertinently to sell bonds back to the market outright. While it may be a tad premature to suggest this, it’s an option should the Fed really want to see longer-dated market rates revert higher.

FX markets: Short-end rates hold the key for the dollar

Dollar price action over the last two months has been very poor. The dollar has tended to sell off sharply on signs of softer price data but has struggled to rally on any positives – such as the November US jobs reports. That price action suggests a market caught long dollars at higher levels after a five-quarter dollar rally. The hope for dollar bulls now is that positioning is much better balanced after an 8% drop in the trade-weighted dollar and a 12% drop in USD/JPY.

Preventing an even sharper dollar sell-off has probably been the view that the Fed will continue to hike into 2023. The terminal rate is still priced not far from 5% and only 50bp of rate cuts are priced in the second half of 2023. As long as the FOMC statement, Dot Plots, and press conference do not generate any more dovish pricing – and that seems unlikely – we doubt the dollar has to sell off much further.

Our baseline view would see EUR/USD holding around the 1.05 area as the Fed validates the current pricing of its trajectory in money markets. A more dovish turn would be a surprise and with seasonals against the dollar in December, EUR/USD could spike above resistance at 1.06 towards the 1.07 area in thin year-end markets.

Our multi-week preference, however, is that the Fed is still going to talk tough, and heading into January the dollar starts to make a comeback – where 4.5%+ deposit rates look increasingly attractive amid a global slowdown.

Source: ING

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Bank of England to Downshift to A 50bp Hike

Devin

Central Bank

The 75bp November hike was a one-off, but we may see one more hike in February

When the Bank of England (BoE) hiked by 75 basis points (bp) for the first time back in November, it seemed obvious that it would be a one-off move. The clear signal was that markets were – at the time – overestimating the scope for future tightening. The forecasts released back then suggested that keeping rates at 3% would see inflation overshoot (just) in two years, while raising them to 5% would see an undershoot. In other words, we should expect something somewhere in the middle, and that's why we think Bank Rate is likely to peak at 4% early next year.

We shouldn't totally rule out a repeat 75bp move on Thursday, and the data flow has leaned slightly hawkish since November's meeting. The Bank's favoured measure of core services inflation, by our estimates, came in slightly higher than it expected – and jobs market data has also shown few signs of cooling just yet. Inflation and jobs data due out in the days prior to the meeting will be important.

Then again, Chancellor Jeremy Hunt probably did just about enough in his Autumn Statement to calm BoE concerns that fiscal policy is working at cross purposes with monetary. While much of the fiscal pain was delayed to future years, the government did still scale back energy support for households next year. With sterling also materially stronger, and markets geared up for a 50bp hike, there's little need to rock the boat with a more aggressive move.

Assuming we're right, we then expect another 50bp move in February which will likely mark the end of the tightening cycle. But with wage pressures unlikely to fully abate even if the jobs markets begin to weaken, we think the BoE will be less swift to cut rates than the US Federal Reserve. For now, we're pencilling in that the first rate cut will come in the first few months of 2024.

The BoE hikes, but the swap curve is focused on cuts

The gilt market has practically shaken off all of the additional risk premium relative to other 'core' government bond markets that appeared around the ill-fated mini-budget. Whilst we would stop short of sounding the all-clear, this is an encouraging sign. The rally has stalled at the 3% level, roughly where 10Y yields were in early September.

Spreads to 10Y Bund are back to just above 120bp but the Treasury rally has brought that spread to -25bp after a trough of -50bp. More cuts being priced out of the GBP curve would bring the spread to Bund to 100bp but we think Treasuries would outperform in any rally, meaning we can no longer exclude Treasuries trading through gilts.

Unlike the USD curve, the focus on rate cuts in 2024 is nothing new. What's interesting is that forwards have inverted more even as hikes were being priced out. This is a notable development because one would expect that higher hikes now also mean less room to cut later. In any event, we think this forward curve inversion is only a transitional state of affairs until either the dovish re-pricing shaves more hikes off the front-end, or more stubborn inflation contradict cut expectations.

Sterling will struggle to make further gains

The BoE's trade-weighted measure of sterling has recovered nearly 8% from its lows in September and is now trading back to levels seen in early August. It looks as though about half of that rally has come from the improvement in the UK's fiscal credibility since the dark days of September. And the other half has come from the broad sell-off in the dollar, where the US currency makes up about 20% of the BoE's sterling basket.

We doubt Thursday's BoE meeting will have too much impact on sterling, where a 50bp hike looks priced. But heading into 2023, we suspect sterling will struggle to make substantial further gains. Here, we doubt GBP/USD can sustain gains over the 1.23 area given our view that the next sizable move in the dollar is probably stronger as the Fed stays hawkish through the first quarter of next year, in spite of the looming recession. And we feel that EUR/GBP will find good support below the 0.85/86 area and favour a return to the 0.87/88 region. Here two-year euro versus sterling swap spreads should remain pretty steady in the 130-150bp area. But a call on a challenging investment environment – central banks hiking into recessions – suggests sterling should under-perform given its higher sensitivity to global equity markets.

Source: ING

Risk Warnings and Investment Disclaimers

Has the 10-Year Treasury Yield Peaked?

Winkelmann

Central Bank Economic

Perhaps the yield curve is the most striking aspect of the Fed's tightening cycle. The key yield curve, which measures the difference between 2-year and 10-year Treasury yields, has been inverted for a long time, which commonly indicates an impending recession. As the Fed's tightening policy is approaching its limit, the time to pause or cut interest rates is getting closer. Is this a prelude to the top of long-term interest rates?

Inflation Has Peaked

Actually, according to recent statistics, energy prices have been sinking due to the relaxation of supply chain tensions and the strike to the demand by the risk of a global recession. Inflation in the United States has shifted the dominance from energy to services, with the largest proportion of which accounts for housing. As we can see, continued rate hikes of the Fed have hit the housing market hard. While mortgage costs are still above 6%. Home sales and new construction have decelerated sharply over the past year. And home prices have also dropped down month-on-month. However, housing rents, as a major driver of the US CPI, have not yet established a downward trend.

Has the 10-Year Treasury Yield Peaked? _2

According to historical law, that house prices in the United States tend to be half a year to one year ahead of rents, the national house price index has begun to decline since April this year. Housing rents will most likely hit the top at the end of this year or early 2023. Even on a high base, the year-on-year growth rate in 2023 will decline gradually. And the inflection point for core inflation will also truly arrive. Taken together, this round of inflation is stepping to an end.

The Inflection Point of Rate Hikes Is Getting Closer

Nowadays, inflation has seen signs of life, which will extend its moderation considerably in the future. Despite the job market is still dynamic, it can mainly attribute to the lagging nature of the monetary policy. As the Fed continued to raise rates, costs of borrowing also have climbed incessantly, which is bound to suppress people's enthusiasm for consumption and investment. Therefore, it is inevitable that the unemployment rate will rise and the demand will shrink in the future. It is what the Fed will have to sacrifice in order to fight inflation.

For the time being, the market estimates the Fed will decelerate the rate hiking to 50 BPs at the December meeting. The hawkish stance of the Fed is eager to its peak. However, the Fed also avoids seeing expectations about overly optimistic markets and renewed easing financial conditions, which could undermine efforts to fight inflation. Therefore, the Fed should avoid not only the risk of a recession exacerbated by immoderate tightenings but also an excessive shift in monetary policy. According to the current statements of Fed officials and market expectations, the better strategy in the future is to release some hawkish signals to dampen market enthusiasm and maintain the rate level for a period of time after raising the rate to a bit higher than 5%.

Has the 10-Year Treasury Yield Peaked? _3

Source: CME FedWatch Tool

With the cooling off in inflation and the job market next year, strategies for the Fed to raise rates will probably be as follow: After a 50bps hike in December, there could be a further slowdown in January and March, with two 25bps hikes separately. At that time, the policy rate will fluctuate in the range of 4.75-5.0, around the expected 5%. So far, it is one step closer to the suspension of interest rate hikes. To make a bold guess, it can already be fully prepared for the final end of the interest rate hike in the first half of next year.

The 10-Year Treasury Yield Could Peak

Since November, the 10-year Treasury yield has fallen significantly, while the short- and medium-term yields were not the same, which has led to a deepening of the US yield curve inversion. It can also be interpreted as the first peak in the 10-year US Treasury rate.

Has the 10-Year Treasury Yield Peaked? _4

Historically, the downward revision of forward policy rate expectations has been the major reason for the decline of the 10-year U.S. Treasury rate in the later stages of the rate hike. Even if the rate hike has not stopped, the US Treasury rate will also decline sharply in line with expectations. In other words, the more interest rates are raised now, the more room for the future to decline and the possibilities will be greater as well. Since short- and medium-term Treasury yields are very sensitive to interest rates, they may keep climbing in the future with the policy rate. However, the Fed's continued rate hikes will strengthen expectations of the forward rate cut but are limited to the impetus of long-term U.S. Treasury rates. Therefore, the risk that the 10-year U.S. Treasury rate will break through the previous high is low.

However, problems with the debt ceiling of the United States should also be noted. In particular, the Republican Party of the US has controlled the House of Representatives. The split in Congress could stunt the rise to the debt ceiling, which will in turn increase the risk of default on US bonds and causes a surge of US bond yields in the short term. Of course, in the longer term, after the end of this round of interest rate hikes, the 10-year U.S. Treasury yield will also be affected by the expectation of interest rate cuts, which contains further downside risks.

Risk Warnings and Investment Disclaimers

After the Bank Run, Where Is the Future of Chinese Wealth Management?

King Ten

Central Bank Commodity

Behind the Bank Run

Yesterday Bloomberg news revealed that the regulation suggested that insurance agencies take back the bonds sold by wealth management. It is just a flow of money from the left hand to the right hand. Where can the money redeemed from wealth management go? Some time ago large certificates of deposit and insurance products were snapped up, and the flow of capital is clear. Now, bank loans are not working, and the money just runs back to the financial markets department of insurance and banks. Do we have to see a certain investment type insurance being run again later? This move is undoubtedly meaningless as the root cause is not solved.

The key point is that the underlying assets of wealth management are based on credit bonds, while the main investors are wealth management, brokerage firms, public funds, and other institutional investors. Previously, by using the cost method or valuation method, the net value of the product will not retract, since the credit bond is not in default, it will always expire. Thus, the high coupon is a steady stream of happiness, so even if the interest rates rise sharply during the mid-way, it is not necessary to passively sell bonds to stop the loss and run. After the release of new rules of capital management for calculating the net value by the fair value, wealth management is getting in trouble. Also, the market is volatile, and the net value of the product will not be maintained, which will further hurt the investors, and therefore redemption is also inevitable.

What Will Be the Future of Wealth Management?

The treasury bonds raised sharply recently, credit bonds are still falling to new lows, and the money flows from wealth management redemption to the bank to buy treasury bonds. Moreover, the current credit bond interest rates are satisfying, but unfortunately, it is difficult for individual investors to enter. What's the lesson this time? There is certainly the valuation problem described above, but the problem of the investors themselves is more significant, including insufficient knowledge about net value, the product, and the risk.

Is the bank run caused by the unattractiveness of price? Obviously, since mid-November, the risk-free rate seems to have moved up sharply, but the ten-year Treasury bond yield also grew up 20bp. If investors experienced financial deleveraging at the end of 2016 and the rapid turn of the bond bear market triggered by the recovery of the pandemic in May 2020, this volatility is normal. The fragility of the market is the key factor in this run on the market! It is better to buy capital preservation and low-yield products if such volatility is unbearable. Additionally, it is estimated that domestic investors will directly choke if they see the volatility of US stock with huge bp fluctuations, which means that our investors are more fragile!

This time, of course, the madness results from the common characteristics of investors: buy when rising and sell when declining. When the net value of the fund rose, investors will increase subscriptions, bank financial investment managers will continue to buy bonds and the net value continued to rise, forming a virtuous cycle. While the net value declines, investors redeem it collectively, and investment managers must sell the product with a loss to cash out. Nevertheless, the whole market is focusing on selling and few investors will buy, leading to the low-price-selling of financial products only cut and sell, and this will form a vicious circle. Thus, it is common for the bond varieties held by the fund products to go up and down 5bps a day.

China's fund industry is very short, starting from the early 1990s, and now has accumulated tens of trillions. Unlike foreign countries with hundreds of years of history, investors are more mature, while Chinese investors are in the stage of enlightenment. Presently, many investors just know to buy the product, without really understanding the product, the stratum assets inside this product, and risk, retracement, or volatility. Probably, financial managers never mention these concepts, but hunting for profits and managing the KYC supervision from authorities. The reality is that there is a complete mismatch between customer acceptability and the product.

What about the future? Will volatility become normal in financial products? If the fair value cost method could not be changed, then the only changeable thing is the investor's ability to accept, to ensure investors know the corresponding risk level of each product, the meaning behind the level, and their acceptance of risk, rather than just cope with R1, R2, R3, R4, R5. Finally, converting from pandemic propaganda: investors should review the risk acceptance and defend the first line of financial products.

Risk Warnings and Investment Disclaimers

Gold Set for Stable Performance in 2023 Despite Market Headwinds

Samantha Luan

Commodity

Gold is set to record a stable performance next year despite a mixed set of challenges, the World Gold Council has said.

The interplay between inflation and central bank intervention will be key in determining the outlook for 2023 and the yellow metal's performance, the trade body said in its Gold Outlook 2023 report.

"There is an unusually high level of uncertainty surrounding consensus expectations for 2023," the WGC said.

"For example, central banks tightening more than is necessary could result in a more severe and widespread downturn.

"Equally, central banks abruptly reversing course — halting or reversing hikes before inflation is controlled — could leave the global economy teetering close to stagflation. Gold has historically responded positively to these environments."

Geopolitical and economic uncertainty is mounting around the globe after Russia's military offensive against Ukraine, with inflation also rising due to higher commodity prices and supply chain disruptions.

The International Monetary Fund cut its global growth forecast for 2023 and warned of a cost-of-living crisis as the world's economy continues to be affected by the war in Ukraine, broadening inflation pressures and a slowdown in China.

The fund maintained its global economic estimate for this year at 3.2 per cent but downgraded next year's forecast to 2.7 per cent — 0.2 percentage points lower than the July forecast.

Gold demand in the third quarter was boosted by consumers and central banks, although there was a notable contraction in investment demand, the WGC said in a November report.

Gold Set for Stable Performance in 2023 Despite Market Headwinds_1

Economic consensus calls for weaker global growth akin to a short, possibly localised recession; falling — yet elevated — inflation; and the end of rate increases in most developed markets.

This environment carries both headwinds and tailwinds for gold, the latest WGC report said.

A scenario of severe recession or stagflation would be considerably tough for equities, with earnings hit hard, but would provide greater safe-haven demand for gold and the dollar, according to the report.

"The likelihood of recession in major markets threatens to extend the poor performance of equities and corporate bonds seen in 2022," the WGC said.

"Gold, on the other hand, could provide protection as it typically fares well during recessions, delivering positive returns in five out of the last seven recessions."

However, a recession is not a prerequisite for gold to perform, the trade body said.

A sharp retrenchment in growth is sufficient for gold to do well, particularly if inflation is also high or rising, it said.

On the flipside, a less likely "soft landing" scenario, where business confidence is restored and spending rebounds, could be detrimental to gold and benefit risk assets, according to the report.

Next year could result in a reversal of the dynamics at play in 2022, which were high retail investment demand but weak institutional demand.

"The retail investor segment appears to care more about inflation than institutional investors, given a lower level of access to inflation hedges. They also care about the level of prices," the report said.

"Even with zero inflation in 2023, prices will remain high and are likely to impact decision-making at the household level."

On the other hand, institutional investors assess their level of inflation protection through the lens of real yields. These rose over the course of 2022, creating headwinds for gold.

Further weakening of the US dollar as inflation recedes could provide support for gold next year, while geopolitical flare-ups will continue to make bullion a valuable risk hedge, the WGC said.

Chinese economic growth should also improve next year, boosting consumer gold demand, it said.

However, pressure on commodities, due to a slowing economy, could provide headwinds to the yellow metal in the first half of next year.

Source: The National News

Risk Warnings and Investment Disclaimers

Fiscal Cavalry Trots to Inflation Battle

Cohen

Economic

With world markets in thrall to the final big three central bank meetings of a tumultuous year next week, the parallel world of fiscal policy takes a back seat. And yet it may be just as crucial to next year's economic and financial outlook.

In one of the starkest economic lessons of a year bamboozled by war in Ukraine and an energy shock, Britain discovered that reining decades-high inflation with interest rates alone is much harder if fiscal policy is rowing in the opposite direction.

The UK's disastrously botched giveaway budget in September set out for many the limits of what's possible in a world of double-digit inflation. Loosen the public purse strings any further and the commensurate level of interest rates needed to then get inflation back to 2% targets balloons, and risks melting the economy down in other ways.

With perhaps less vulnerability to foreign investment flows and currency shifts than Britain, the United States and euro zone have been dancing with that problem too amid serial economic rescues and recovery plans over three years of pandemic, war and energy crises that hit the trillions.

For all intents and purposes, the past three years have been the budget equivalent of a war footing for Western governments. Just as inflationary too - and in need of normalising.

But the room for and extent of the fiscal clawback in 2023 and 2024 may well determine how much harder central banks have to squeeze credit from here.

Less in need of same level of new energy price supports Europe was forced into, U.S. government spending was already checked this year by Democrats' razor thin Senate majority and the objections of Democratic Senator Joe Manchin.

That majority increased by one after last month's mid-term elections and this week's Georgia runoff. But Democrats lost the House of Representatives by a narrow margin too and that likely enforces rather than loosens spending gridlock.

Britain's bond blowup in September, meantime, forced a swift change of prime minister and finance minister and a dramatic fiscal U-turn that now ushers in austerity more than stimulus.

A hazier picture prevails in the European Union, where support for Ukraine, higher military spending and EU attempts to wean itself off Russian natural gas and oil leaves less room for retrenchment.

In its latest economic outlook late last month, the Organisation for Economic Cooperation and Development reckoned energy uncertainty clouded the picture but "moderate" fiscal consolidation was indeed still likely over the next two years.

The median OECD economy was forecast to see an improvement of underlying primary budget balances, which exclude interest payments on outstanding debt, by some 0.4% of potential GDP next year and 0.6% in 2024.

And the United States stands out in that regard. The OECD sees a full 2% of potential GDP improvement in its primary balance over the two years combined.

And yet while inflation lifts nominal GDP and public revenues, the hit from a real GDP recession, higher debt servicing costs and lingering or poorly-targetted energy supports sees total debt burdens continue to climb.

Only Sweden, Portugal, Ireland are set to have lower debt/GDP ratios in 2024 than in 2019, according the 38-member OECD.

Describing the debt service outlook as having "deteriorated substantially", it said long-term borrowing costs of 10 years or more had risen significantly above so-called "implicit interest rates on public debt" - the interest paid as a share of the nominal debt stock. And this simply pointed to "more costly debt finance in the future".

'Brute force'

All of which begs the question of whether central banks will have to conduct the inflation fight on their own.

Some try to see it terms of the "monetary policy space" a government's spending and debt accumulation - and that of companies and households - affords its central bank.

Societe Generale strategist Solomon Tadesse this week modelled it over time, looking at whether a greater fiscal burden and higher debts over recent decades - supported by low interest rates or outright central bank bond buying - had in fact lowered the point at which higher interest rates bowl the economy over.

Tadesse pointed out that the Federal Reserve of former chair Paul Volcker was able to raise interest rates as high as 19% in the 1980s without causing a recession - but recession now looms again with Fed rates approaching a quarter of that.

He blames "fiscal indiscipline" over the intervening period and fears the limit that imposes on the use of interest rates to control inflation just risks baking in bloated central bank balance sheets in a "vicious circle".

And likely severe recessions from historically modest interest rates just force central banks to quickly return to so-called quantitative easing, undermining their own longer-term inflation battle.

"For markets, brute force monetary tightening without concomitant fiscal discipline that significantly slashes budget deficits and debt financing may only provide a temporary reprieve - if any at all," Tadesse said. "Sustainable normalisation out of the current crisis would call for meaningfully addressing deficit financing."

Using the Fed's overall U.S. government debt holdings as a proxy for fiscal discipline, Tadesse estimated that a reduction from current levels of about 25% of GDP to pre-pandemic levels of 10% could create greater monetary policy space - allowing a peak policy rate of 9.85% without triggering a hard landing.

It would also allow the Fed to shrink its balance sheet by about $4.36 trillion, reversing almost all of its pandemic QE.

Debates rage about the real causes and durability of this inflation surge, the connection between public debt and economic activity and the extent to which deficits matter at all.

At the very least, a test of these ideas is coming. If the Fed and other central banks pause tightening to cope with rising unemployment next year, it's not yet clear they'll have succeeded in putting inflation back in its box by then. Fiscal Cavalry Trots to Inflation Battle_2

Fiscal Cavalry Trots to Inflation Battle_2

Source: Reuters

Risk Warnings and Investment Disclaimers

ASEAN the Expected Outperformer in 2h2023, But Malaysia Will Be Bogged Down by Fiscal Risk, Weak Global Demand

Thomas

Bond

India and Asean are seen to lead the global economic recovery in the second half of 2023 (2H2023), said Nomura, but Malaysia could face hiccups due to weak external demand and fiscal reform challenges amid the current political landscape.

Nomura Asean chief economist Euben Paracuelles said the research house is cautious on Singapore and Malaysia, with the boost from economic reopening seen fading and taken over by weaker external demand in early 2023.

Paracuelles anticipated Malaysia's upcoming Budget 2023 to reflect a fiscal deficit of 5.8% to gross domestic product (GDP), unchanged from 2022, as opposed to the initial official estimate of 5.5%.

"The main risk that we're seeing here is actually an increase in fiscal risk after the recent election," he said at the Nomura 2023 Asia Economic, Currencies & Equities Outlook.

"In the environment where the economy is already slowing down, we think the slowdown from the external backdrop will get exacerbated, because in Malaysia what happens to the export sector tends to get translated into domestic demand very quickly," he said, citing the close correlation between exports growth and wage growth.

The weak exports seen in 1H are on the back of recession forecast in the Group of Seven economies, including in the US (-0.8% GDP growth forecast in 2023), eurozone (-1.4%) and the UK (-1.5%).

"Weak wage growth due to the weak export sector would lead to issues in consumption spending.

"Plus the fact that the recent election showed a more fragmented political landscape, we think it will be very difficult for the government to implement very quickly some fiscal reform measures including subsidy rationalisations and even the more difficult ones to broaden the tax base," he said.

However, Paracuelles does not see Malaysia being able to postpone the fiscal reforms much longer, as credit ratings pressure could resume otherwise.

"Given the global downturn next year, there might be an understandable rationale to delay, but by 2024, if economic conditions improve, implementing a credible fiscal consolidation medium-term agenda needs to begin," he opined.

On the wider Asean, Nomura head of global macro research Rob Subbaraman said the region, alongside India, is seen as the rising star of Asia in 2023.

"We think they've got everything to play with to lift their potential growth rates compared to other EM (emerging-market) regions — relatively healthy fundamentals, young population, rapid digitalisation is happening in these economies. And China-plus-one investment flow could unlock a little bit of growth potential as well," he said.

Malaysian equities downgraded to underweight

The fading pandemic recovery boost also has the research house downgrading Malaysian equities to underweight from neutral in its 2023 outlook anchor report for Asia, ex-Japan.

While Asian stocks have valuation support and light investor positioning, Nomura sees a rotation of funds into North Asia such as China unlikely to help Malaysia's foreign fund flow picture.

That said, it sees some value in the commodities sector. Another bright spot is tech stocks, amid record net balances and improved valuations following the recent sell-off — although the first quarter of 2023 remains volatile due to US slowdown concerns, the report said.

Nomura's core Asia ex-Japan long only barbell strategy includes Press Metal Aluminium Holdings Bhd as a potential beneficiary of China's reopening, and reviving demand in infrastructure-related activities.

It also includes Inari Amertron Bhd, in anticipation of the bottoming out of the smartphone industry down cycle, coupled with its ongoing strategic initiatives in China, Malaysia and the Philippines.

Source: The Edge Markets

Risk Warnings and Investment Disclaimers

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US Federal Reserve preview: trapped between a rock and a hard place

A step down to a higher peak

Scenarios for the 14 December FOMC meeting

Signalling could fall on deaf ears

ING's expectation for what the Fed will predict

Inflation makes things tricky

5% in the first quarter but rate cuts from the third

Market rates have dropped like a stone – time for the Fed to sell bonds?

FX markets: Short-end rates hold the key for the dollar

Source: ING

Bank of England to Downshift to A 50bp Hike

The 75bp November hike was a one-off, but we may see one more hike in February

The BoE hikes, but the swap curve is focused on cuts

Sterling will struggle to make further gains

Source: ING

Has the 10-Year Treasury Yield Peaked?

Inflation Has Peaked

The Inflection Point of Rate Hikes Is Getting Closer

Source: CME FedWatch Tool

The 10-Year Treasury Yield Could Peak

After the Bank Run, Where Is the Future of Chinese Wealth Management?

Behind the Bank Run

What Will Be the Future of Wealth Management?

Gold Set for Stable Performance in 2023 Despite Market Headwinds

Source: The National News

Fiscal Cavalry Trots to Inflation Battle

'Brute force'

Source: Reuters

ASEAN the Expected Outperformer in 2h2023, But Malaysia Will Be Bogged Down by Fiscal Risk, Weak Global Demand

Source: The Edge Markets

Risk Disclosure