Login / Register
At a time when economic activity surveys are at record levels, unemployment is trending down, inflation is close to its optimal rate (averaging around 2% in the long term), corporate profits, which were already high, are surpassing all expectations, the central bank is maintaining an ultra-accommodating stance and huge new investment plans are on the way, what more can we possibly ask for? Of course, we should aim for the stars, but when we reach them, what lies beyond?
The market is asking this question about the US economy.
And, since the answer is not obvious, the market is stalling. Thus, this week's trading sessions have experienced significant volatility, with almost no progress to show for it.
The question is not so much about future profits, which seem assured for the next few quarters, but about rates, linked to inflation. If inflation proves to be transitory, as the Fed assures us it will be, it is unlikely to affect the market. If it persists, however, it could trigger monetary tightening, which in turn would adversely affect equities.
Central banks have therefore intervened to provide some stability. There was near unanimous agreement among central bankers that the Fed would remain accommodative for a long time to come, as high inflation in the US was artificially linked to base effects and temporary supply-side shortages, and unemployment was still far from being brought under control.
For those of us who are still not totally convinced, it is worth looking at other similar situations and examining the outcome. In this particular case, the evidence can be found in another star-studded country – but one with five stars on its flag, not fifty. Over the past few years, China seems to have been ahead of the rest of the world, experiencing episodes of inflation, recession, rebound and finally normalisation before other nations. As such, it is leading the way – or at least plotting its own course.
Take inflation, for example. It surged to more than 5% in early 2020, due to what was essentially a temporary effect: the price of pork – not, as is currently the case, that of chips (electronic chips, that is). Since then, inflation has fallen back to below 1%. Issue resolved.
From an economic perspective, China also entered a recession before anyone else, in early 2020, and then experienced a sustained rebound from April 2020. Since then, the economy has stabilised at a high level without overheating. And its monetary policy has moved from slightly accommodative in 2020 to neutral or even slightly restrictive without causing disaster. China's 10-year yield even hit a low of 3% this week, in a sign that its fixed income market remains calm. This is in contrast to the US fixed income market which, despite having calmed down recently, experienced a chaotic start to the year.
So, China may well represent the future picture in the US – at least as far as the economic and inflation outlook is concerned. There are of course differences to consider that limit the scope of this comparison: first, China's inflation was linked to one particular component – food – and not to several factors as may be the case in the US. Currently there is one main factor driving inflation in the US too: the price of cars. But if wages were to be included, as some indicators suggest, then price dynamics would change dramatically. In addition, China has provided far less stimulus to its economy during this latest crisis than the US. Moreover, Chinese monetary policy has proved far less accommodating. And then, of course, China's economic and demographic structure is very different.
Despite this, China has found a successful path towards normalisation and, with a few adjustments, could serve as a useful model for the future.
As for the 12-star continent – made up of 27 countries – which path is it following? Surprisingly, the area with the least growth and inflation has seen its rates rise sharply in recent weeks: the German 10-year bond yield came close to -0.10% this week, bouncing back from -0.57% at the beginning of the year. Is this a sign that the race to the stars is finally underway in Germany? The good news is that it need not worry about what is beyond the stars for now: it has to reach them first. We wish them a successful launch.
Olivier de Berranger, CIO, LFDE