In China and the US, economic recovery takes a disappointing turn
The unexpected provokes the strongest reactions. Markets are no different. Pieces of news that change commonly held expectations tend to set money in motion. For example, a very poor economic data point could be shrugged off by the markets if it was expected and already reflected in prices. It’s the change in expectations relative to consensus that really matters.
A recent case in point is the price of bonds, which have been edging higher, and yields lower (yields move inversely with prices) because much of the recent economic data has been surprising, disappointing expectations.
The potential for a slowdown in China and the United States, the world’s two largest economies, is feeding concerns that global economic growth may have peaked, and increasing caution about an economic slowdown.
This has prompted a rally in safe-haven assets, such as US Treasuries, keeping bond yields low (meaning prices are high), and offsetting the forces that would normally drive yields higher, including the potential for stubborn inflation and the tapering of bond purchases by the US Federal Reserve and other central banks.
The flurry of economic data out in recent weeks has substantially disappointed against the consensus forecasts. In the US, a consumer sentiment report for August revealed a big setback in confidence and was followed up by a drop in retail spending.
In China, it’s a similar story. The monthly economic data for July illustrated a broad-based slowing in economic activity as retail sales and industrial production growth rates were lower than expected.
It’s not just disappointing data that the two markets have in common. Both are much further along their recovery path than other economies around the world. China has already replaced all the economic output it lost during the pandemic and the US is not far behind. Naturally, this means that economic growth rates should now moderate.
Additionally, both countries are facing another wave of Covid-19 cases as the more contagious Delta variant spreads through populations, even as vaccination rates in both countries are relatively high. Delta is the biggest risk when it comes to the outlook for any economy.
Some of the slowing in China is by design. Earlier in the year, officials moved to restrict the flow of credit in the economy in an attempt to prevent unwanted economic imbalances and potential asset bubbles.
The lingering effects of reining in credit are still being felt, even though some moderate reversal of these measures is now in the pipeline.
Further monetary and fiscal policy stimulus is likely in the coming months via cuts to the reserve requirement ratio and use of special and local government bonds to finance infrastructure projects. This should provide some comfort to investors about the potential magnitude of economic deceleration.
Meanwhile in the US, the weakness in activity, particularly in retail sales and consumer confidence, is more closely linked to the rapid spread of the Delta variant rather than policy actions. Hospitalisation rates are rising in line with case numbers, despite the high vaccination rate.
The importance of the US consumer shouldn’t be understated. Consumption in America accounts for around 70 per cent of real GDP and is the real powerhouse of the economy.
The political response has been muted to this increase in cases and hospitalisations, but consumers may be cutting back, preparing for the possibility of some restrictions being reimposed.
Despite the recent hit to confidence, household balance sheets in the US remain strong, bolstering the economy. Much like what happened in Britain, where case numbers did spike after the initial reopening before they eventually started to fall, this may play out similarly in the US.
Vaccines should also sever the link between case numbers and hospitalisation rates, easing fears around the virus and seeing consumption activity increase again.
China and the US set the tone for a global economy that is coming off peak growth. But the recent virus-induced dips in economic activity shouldn’t significantly alter the medium-term positive view of either superpower.
In the case of the US, this is a reflection of its economic trajectory shifting from early- to mid-cycle, suggesting that bond yields should rise and equities should continue to do well. Many other parts of the world are further back in their own recoveries, with plenty of scope for catch up, to drive the outlook for earnings and equity markets.
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Kerry Craig, Executive Director, is a Global Market Strategist. Based in Melbourne, Kerry is responsible for communicating the latest market and economic views from our Global Market Insights Strategy Team.