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Investment Weekly: Central bankers: should I stay or should I go?

25 Mar 2024

Key takeaways

  • The 10-year BTP/Bund spread has fallen to its tightest since November 2021. That follows a pattern of other global credit spreads compressing to new tights.
  • The starting point for our global macro scenarios is the recent experience of ‘Reaccelerating Growth’ amid a virtuous cycle between robust consumption, resilient profits, and a strong labour market.
  • In India, the 2015 Digital India initiative helped move the country higher up the tech value chain. Since the fourth industrial revolution began, technology has been adopted in different ways as a crucial enabler of economic growth.

Chart of the week – Central bankers: should I stay or should I go?

It’s been a big week for central banks. And the key question has been: “should I stay or should I go?”. The Bank of Japan answered with a historic decision to exit from negative interest rates, following the highest shunto pay round negotiation since 1991. The Swiss National Bank surprised markets with a 25bp rate cut, with inflation below 2% since the summer.  

Meanwhile, the Fed and BoE decisions to ‘stay’ were hardly a surprise. But the Fed maintained its projection of three rate cuts in 2024, despite some recent upside inflation surprises. And the BoE hawks fell in line with the majority vote to hold. 

The implications for investment markets are complex. On a tactical basis, rate cuts being on the table is undoubtedly supportive for risk appetite. But much will also depend on the pace of cuts, especially with a bumpy ‘last mile’ of disinflation ahead of us.

And where will interest rates ultimately settle? Structurally tight labour markets are set to keep upward pressure on wages. Global economic fragmentation raises input costs. And fiscal policy is activated. These forces make a return to the ultra-low interest rate regime of the 2010s unlikely. Instead, a new paradigm of higher rates is coming into view. 

Market Spotlight

Steady as she goes for EM easing

A number of EM central banks also met this week. The bottom line is interest rate cuts are progressing in much of Latin America and emerging Europe. Banco Central do Brasil delivered another 50bp cut, while Banxico kicked off its easing cycle with a 25bp cut. Czechia also cut for the third time in a row. 

But could there be trouble ahead? Earlier this month, Peru unexpectedly held off on another rate cut, reflecting concern over February’s inflation surprise. Central bankers in Brazil shortened their forward guidance on cuts, citing slowing global disinflation and some stickiness in services. That message was echoed by the Czechs. 

All in all, this suggests policy normalisation could become more gradual, especially if the Fed delays cuts and EM FX depreciation becomes a more material concern. But with EM stock market multiples significantly less stretched than DM counterparts, further policy easing – even if measured – provides a potential catalyst for rerating. A tailwind to EM asset returns may also come from gains in EM currencies – which still look very cheap. The Fed and ECB kicking off their easing cycles could unlock some of the value here.

The value of investments and any income from them can go down as well as up and investors may not get back the amount originally invested.

Source: HSBC Asset Management. Macrobond, Bloomberg. Data as at 11am UK time 22 March 2024. 

Lens on…

Italian bonds are back

The 10-year BTP/Bund spread has fallen to its tightest since November 2021. That follows a pattern of other global credit spreads compressing to new tights.

What makes the story interesting in BTPs and Bunds is the speed at which spread compression has played out. Since last November, the spread has squeezed lower by about 80 basis points. That’s a fast move in the context of what we normally see.

So, the drivers of the BTP/Bund move are partly global, and partly local. The global element is the increased confidence that market participants have in the ‘soft landing’ scenario (or something even better). The local part relates to the upgraded outlook by Moody’s late last year to ‘stable outlook’. 

Even so, the rapidity of the move is a concern and could prompt some short-term volatility. The economic outlook continues to look okay, but just maybe not quite as perfect as what markets are now priced for.

Exploring the macro outlook

The starting point for our global macro scenarios is the recent experience of ‘Reaccelerating Growth’ amid a virtuous cycle between robust consumption, resilient profits, and a strong labour market. But looking ahead, it’s likely this will give way to one of three key scenarios. Perhaps the most desirable of them is the ‘Golden Path’, which envisages rising productivity growth driving GDP growth higher and delivering further gains in risk assets. 

The most bearish is the ‘Hard Landing’, where dogged inflation spurs tighter-for-longer policies that hurt companies and consumers to the point of recession. A middle ground – and perhaps the most likely for now – is the ‘Softish Landing’, characterised by disinflation, economic resilience and central bank rate cuts – but with some bumps along the way.

India’s digital empowerment

Since the fourth industrial revolution began, technology has been adopted in different ways as a crucial enabler of economic growth. 

In India, the 2015 Digital India initiative helped move the country higher up the tech value chain. The government’s commitment to leveraging technology to drive economic growth has helped put it on course to be the world’s third largest economy by 2027. Out of a population of 1.44 billion people, it boasts 1.2bn internet users, 1.14bn mobile subscribers, and 800m e-commerce users.

In short, the potential is significant given the government’s desire to boost domestic consumption via technology, and encourage firms to spend in areas like automation, robotics, AI and cloud computing. 

Naturally, this has encouraged a vibrant and experimental start-up community. India now boasts the third largest start-up ecosystem with its number of domestic unicorns (private firms with valuations of more than USD 1bn) now only behind that of the US and China. Meanwhile, quoted tech stocks have performed well, with the S&P India Tech index up by more than 30% over one year.

Source: HSBC Asset Management. Macrobond, Bloomberg. Data as at 11am UK time 22 March 2024.

Key Events and Data Releases

Last week

The week ahead

Source: HSBC Asset Management. Data as at 11am UK time 22 March 2024. 

Market review

Dovish comments from Fed Chair Powell, reiterating that rate cuts are on the agenda in 2024, spurred a rally in risk markets, with core government bonds posting modest gains. The Swiss National Bank cut rates by 25bp to 1.5%, the first developed country to ease policy. In the US, the S&P 500 and Nasdaq reached all-time highs, with the Russell 2000 rising to a two-year high. Eurozone stocks posted decent gains. In Asia, the Bank of Japan exited its Negative Interest Rate Policy, raising rates for the first time since 2007, but BoJ governor Ueda failed to signal further rate hikes near-term, boosting the Nikkei as the yen weakened. In EM, the Shanghai Composite Index rose amid mixed Chinese data. Taiwan’s central bank surprisingly hiked rates by 0.125% to 2% to contain inflation. In commodities, oil consolidated after recent gains, while gold reached a historic high.

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