• Funds Blog
• January 10, 2025

Continued Monetary Easing Amidst Rising Inflation

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As investors gear up for the fourth quarter, the backdrop of continuing monetary easing and a slight rise in inflation presents a mixed bag of opportunities in stock and bond marketsFor those focused on bonds, short-term debt may hold certain advantages, while resource stocks could shine amidst fluctuating economic conditionsThe introduction of new policies and gradual economic improvements raise the pivotal question of how investors should navigate the balance between equities and fixed income.

The unfolding scenario is largely influenced by the political landscape, which has become a significant marginal variableWith central banks in June and August implementing interest rate cuts, followed by a reserve requirement ratio reduction in September, the overall stance of monetary policy appears quite proactiveThis indicates a strong intention to spur economic growth, suggesting that investors may lean towards holding more equities, possibly favoring financial and cyclical stocks.

However, the reality may be more nuanced than anticipated

Historical data suggests that such macroeconomic policies usually correlate with robust economic stimulus, leading investors to prefer an "overweight on stocks, short on bonds" stance, particularly with an inclination towards high-beta financials and cyclical playsNevertheless, recent shifts in economic structure have altered how markets respond to these fiscal alterations, demanding a re-evaluation of how policy affects asset allocation.

Positive indicators surrounding both domestic and international demand suggest gradual improvements, yet the influence of expansive monetary and fiscal policies is still in a corrective phase from prior tightening stancesWhen examining the inherent levels of policy, it may not classify as overly expansive due to several key factorsNotably, the current inflation-adjusted real interest rates remain highFor instance, subtracting the core Consumer Price Index increase from the yield on two-year treasury notes reveals a real interest rate around 1.3%, significantly higher than the 0.5% level observed during previous years of economic stimulus (2016 and 2020).

This situation raises concerns about the Federal Reserve's hawkish tendencies, maintaining its stance above market expectations

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This persistence urges domestic policymakers to calibrate interest rate adjustments prudently, considering the strong resilience of the U.Seconomy and the ongoing inflation-resident cycleFurthermore, while the absolute levels of general fiscal expenditure appear weak—with August fiscal spending growth only reaching 7.2%, having recently transitioned from negative to positive—the effects on non-governmental economic activities typically require several quarters to materialize.

Additionally, traditional indicators of fiscal health also suggest limited strength, as the fiscal intensity (measured here as a ratio of public budget deficits, special bonds, and land sales revenue to nominal GDP) stands at around 10%. This figure aligns with the relative intensity of efforts observed in 2018 but lags behind the robust growth measures enacted in 2020 and 2021. The counter-cyclical effects have not been pronounced in a manner necessary to invigorate risk appetite across the financial spectrum.

One of the pressing concerns is how the long-term changes in real estate and demographic cycles manifest short-term impacts on the economy

Despite efforts to stimulate growth through real estate as a tool, its influence appears to be diminishing as the current inventory cycle aligns with broader market weaknessesHowever, there are slight silver linings; the continued reduction of mortgage rates and localized easing measures have seen the year-over-year decline in residential property sales narrow from -15.5% to -12.2% by August, indicating a potential stabilization in absolute sales volumes.

Looking forward to the fourth quarter, several favorable elements are expected to prevail, notably the favorable policy climate coupled with favorable liquidity conditionsAs long as housing prices do not significantly escalate, the prospect for ongoing monetary easing remains intact, especially as maintaining appropriate liquidity becomes increasingly vital to managing debt effectivelyThe fiscal policies entering the spending phase could provide a release of capital into the economy, reinforcing positive liquidity both for the real economy and financial markets.

Additionally, any unexpected dovish pivot by the Federal Reserve in Q4 could lead to further interest rate cuts domestically

Amidst these developments, a more proactive overhaul concerning the economic fundamentals is anticipated: growth is expected to be seated at the lower bounds of economic performance, and quarterly economic data could show promising recovery trends with core inflation likely to see a gradual increase.

In alignment with announcements of key economic indicators such as rising PPI and turning lanes in manufacturing PMI, the export sectors, corporate inventories, and global manufacturing indicators are anticipated to enjoy enhanced stability in Q4. Such dynamics sketch optimistic possibilities for market participants, needing an astute eye on evolving sectors and opportunities.

From this compounded analysis, a few clear asset allocation strategies emergeFirstly, the prevailing decline in risk-free interest rates remains a trend that is yet to concludeThe late-August to September uptick in rates appears unsustainable, and a potential resumption in downward momentum could usher in favorable scenarios for bonds—prominent especially in the short-end of the interest rate curve—while also aiding in correcting stock valuations.

Moreover, corporate profitability is likely to rebound alongside an improving economy

Between January and August, China’s industrial enterprises above a designated scale reported total profits of ¥46,558.2 billion, reflecting an 11.7% year-over-year decreaseHowever, this decline is less severe than prior months, revealing a 3.8 percentage point improvement from the previous January to July metricsSome telling sectors such as electricity, thermal energy production, and relevant sectors have experienced profit growth of as much as 53.4% year-on-year.

Yet care must be taken as the ongoing rise in PPI is more influenced by external supply-demand dynamics rather than purely domestic consumptionThis suggests that while upstream resource profitability is improving significantly, recovery among lower-tier manufacturing remains subdued, reflecting limited upwards potential for EPS growth across A-share companies heavily reliant on consumer demand.

Lastly, in terms of market characteristics, given the prevailing economic and policy climates where restorative measures dominate and a fully-fledged upward economic cycle seems unlikely, sectorial investment strategies should focus on opportunities related to upward corrections