Economic Insights for April 2022

The following are some economic insights for April 2022.  We must acknowledge that Russian military action in Ukraine had resulted in impulsive reactions in the market, which has dampened risk sentiment.  The markets have been unclear as to how the situation will develop since the war commenced in late February.  There continues to be further escalation of sanctions by the West. Peace talks between the two sides are still inconclusive.  This has the direct consequence of higher commodity and energy prices.  Central banks are caught between a rock and a hard place: either curb inflation or support economic recovery.  As a result, we are experiencing higher than expected inflation, dampening growth. 

On the other hand, monetary policy normalisation has accelerated further in the March.  Several key central banks have announced more interest rate hikes in a shorter period of time than expected previously. More are expected to follow.  While current inflation pressures are created by a series of shocks, such as Covid-19 and the Ukrainian invasion, central bankers are concerned by second round effects, such as the wage-inflation feedback loop, if current inflation is not addressed. 

GDP growth will likely remain above potential in 2022, but the conditions of the market from 2020 implies an apparent decline in growth compared to 2021.  This combination of supportive growth and aggressive monetary normalisation creates an unstable configuration for equities.  Bonds will rebound in real rates, maintaining a downward pressure on returns, although a significant part of this process is already reflected in prices. 

Asset allocation decision remains one of the largest drivers when determining the range of portfolio outcomes amid these volatile markets.  Thus, the backdrop of strong macro fundamentals remains a valid narrative for risk assets to outperform in 2022.  Among the various risk assets, profit margins and return on equities continue to reach record highs for all markets, especially for the US and Eurozone.  Meanwhile, earnings revisions and breadth have started to look more favourable for Asian markets.  China’s easing of monetary policy, coupled with the new shift in Covid strategy from Covid-zero to “dynamic zero”, and the support from state-backed funds to buy China A shares are early signals to the beginning of a more sustained recovery in the region.  Or, at least we hope. 

In summary, equities are expected to record above-trend growth among major developed economies.  This is expected to continue in 2022, supporting the momentum on earnings growth.  This is also expected to withstand the impact of the Federal Reserve hike to equity valuation.  In essence, markets may have quickly priced in the risk of monetary policy normalisation.  This has cleared the way for risk asset outperformance.  As such, earnings expectations have started to look more favourable for Asian markets supported by reopening of ASEAN economies and the expectation of more policy support from Chinse government and recovery of credit growth. 

Regarding investment-grade credit, Asian credit is likely to outperform US credit, considering the credit spread premium from Asian counterparts.  This is especially so, against the backdrop of increasingly diverging monetary policy by key central banks in the West versus the accommodative Asian counterpart, as well as the easing at the People’s Bank of China.  Tightening financial conditions in the US, higher US Treasury yield and longer duration of US Investment Grade credit relative to Asia excluding Japan, in both rate and spread terms, imply risk-reward tilts towards Asian credit over US credit. 

In terms of Treasuries, the Federal Reserve’s new pivot to focusing on fighting inflation expectations has proven to be more aggressive than expected.  The short rates have been moving upwards quicker than the long-end, causing the yield curve to flatten materially, bringing it close to inversion even though economic fundamentals remain robust in the near term.  Over a medium investment horizon, we expect higher rates volatility and weaker price performance.