Not only are stock-picking skills a key component to how competent an investor is, being cognizant of global political and economic developments, with monetary policy trends among the most important elements, is another.
But perplexed by whether the surging inflation levels are structural or transitory; and, if it is indeed structural, will central banks extend a greater degree of tolerance towards persistent inflation, or will their determination to tighten policies and stabilize price rises at 2% trump everything else, the current market is all but certain about where future monetary policies are headed.
Recent economic data and the Federal Open Market Committee’s (FOMC) meeting minutes can perhaps shed some light on the questions above.
Among major economies globally, the US has shown the strongest economic growth thanks to its aggressive fiscal and monetary policies, with its GDP figures surpassing pre-pandemic levels. Compared with the US, both the EU and UK have seen a more moderate pace in economic growth, with Japan largely lagging behind1. But China, even though it is least affected by the pandemic, could be confronted with headwinds including the recent clampdown on the property market, a potential slowdown in export growth, and businesses being slow to adapt to antitrust laws, among other risks.
Moreover, divergence in growth trajectories could also influence the direction of future monetary policies. The FOMC meeting minutes released in early November indicated that debt purchases in its quantitative easing program will be gradually drawn down starting December. In November, the Fed bought US$70 billion in Treasury bonds and US$35 billion in mortgage-backed securities each month, which will be scaled back by US$10 billion and US$5 billion per month respectively. At this rate, the Fed will be wrapping up its bond-buying program by the end of June next year. But when will it begin raising interest rates? Richard Clarida, Deputy Director of the Federal Reserve, believes that the end of next year could be an optimal time to start doing so.
And the Bank of England, which has largely concluded its bond-purchasing program, is looking to raise the target interest rate from the current 0.1% to 1% by the end of 2022; and only after which point would it also consider dialing back the quantitative easing measures. Given the UK’s weaker growth momentum compared with that of the US, raising interest rates prematurely runs the risk of stifling budding signs of economic growth.
While the EU has exhibited a slower recovery rate, not unlike the UK, European Central Bank Executive Committee member Philip Lane recently pointed out that it is cognizant of the region’s pressure points: the lack of a unified fiscal policy, high debt levels among many countries, and a yet-to-recover economy, so it would remain mindful of the pace at which it tightens its monetary policies.
As for China, the laggard economic data it printed recently has raised the likelihood of the country easing its monetary policy. Having said that, we think that the authorities would implement easing measures with control, with bank loans targeting specific industries to prevent speculative activities in the property market.
As things stand, the US looks to be the first to tighten its policies among Western countries, pointing to a potential appreciation of the US Dollar Index. Given the dollar’s role as a reserve currency, the implications of rate hikes and a stronger dollar are multifold. Here are several scenarios we think would play out:
Non-dollar denominated commodities will first see their prices rise as global raw materials and precious metals are all priced in USD, leading to a decline in demand and weighing down their prices.
Also, the tightening of monetary policies will translate to fewer investors using precious metals to hedge against the risk of excessive money supply as precious metals prices are closely tied to the US’s monetary policy. It’ll also strain their prices as a result.
Lastly, interest rate cuts in the US would typically lead to an outflow of the dollar as investors seek higher returns abroad, which would benefit emerging markets. But if the US does stop buying bonds mid-next year as expected, emerging markets economies will likely come under pressure – we think investors should be mindful of how such impact gets transmitted.
 Source: Fred Economic Data, as of Nov 2021
 Source: Federal Reserve press release, as of Nov 2021
 Source: Board of Governors of the Federal Reserve System, as of Nov 2021
 Source: Bank of England, as of Nov 2021
 Source: European Central Bank, as of Nov 2021
This document is based on management forecasts and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. In preparing this document, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources. All opinions or estimates contained in this document are entirely Zeal Asset Management Limited’s judgment as of the date of this document and are subject to change without notice.
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