Resilient US economic data and hawkish Fed underpin the base case from the H2 outlook presented by Standard Chartered, calling for a delay of the recession to Q1 of 2024. During H2, the markets will likely be caught between two extreme scenarios: a recession case (implying risk assets should be avoided) vs a “no-landing” scenario (equities should be chased higher). SC says we will likely fall somewhere in between, and investors should keep CALM.
Fed Chair Powell repeatedly highlighted over the week the possibility of up to two rate hikes before the end of this year. This was notwithstanding the June manufacturing PMI that fell further in contractionary territory. US equities slumped earlier on recession fears, only to rebound as consumer confidence, new home sales and durable goods orders surprised positively.
Against the strong US consumer data and the Fed’s commitment to fighting inflation, the market-implied probability of a 25bps rate hike in the upcoming July FOMC meeting shot up to over 83%. SC says it is watchful of the PCE core deflator as a better gauge of the next Fed move. But any rate hikes for the rest of the year will only exacerbate the tightening of monetary conditions at a time when more liquidity will be sucked out of the system by the Treasury General Account refill. This makes the delayed recession case more likely.
Noticeably, USD/JPY has edged higher to 143-145, despite comments from Japan’s key currency official, Masato Kanda, this week that he would not rule out the option of intervention. Based on options market pricing, markets assign a low probability to any intervention, at least until the JPY weakens towards 150. The house believes interest rate differentials and BoJ policy remain key to USD/JPY.
USD/CNH surged past 7.25, despite the PBoC’s moves to set the reference rate at 7.22. Apart from widening interest rate differentials, the CNY also reacted to the less-than-desirable economic data in China. First, tourism revenue during the Dragon Boat Festival declined 5.1% from the 2019 level, implying per-capita tourism spending fell by 15%. Second, industrial profits contracted by 18.8% in the first 5 months of 2023 (page 3). Against all this, Premier Li Qiang’s speech at the Summer Davos Forum this week, emphasizing more effective measures to tap the potential of domestic demand, has reignited hopes for policy support.
While markets are pricing more US rate hikes this year, the 10-year government bond yield is likely capped by delayed recession fears, trading in a range and facing strong resistance at 4%. With the 10-year yield likely to retreat to 3%-3.25% in 12 months, the CALM strategy calls for an Overweight on high-quality bonds, with a tilt to long duration, as a key tenor to Capitalise on market conditions. The other prong is to have a core allocation to global equities.
Allocating broadly across asset classes, e.g., gold, is key to building a diversified foundation portfolio. Gold deserves a core allocation, given Emerging Market central banks’ buying and geopolitical risks. This week’s (short-lived) unrest in Moscow and the anticipated intensification of the US restrictions on chip exports to China serve as good reminders.
Lean to Asia USD bonds and Asia equities: Near-term view on the JPY is supportive of a positive stance on Japan equities. SC anticipates China equities to be supported by targeted fiscal policy measures from the July Politburo meeting. The house recommends a balanced positioning between onshore and offshore China equities.
Last, but not least, Managing volatility is important in navigating uncertain times.
By Raymond Cheng For SC
