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Hawks vs. Growth Headwinds

July 28, 2022

Read Time 2 MIN

The Fed delivered a hawkish hike just as the Q2 GDP growth surprised massively to the downside. China’s growth forecasts are being cut again, but the Politburo is not too keen on massive stimulus.

Fed Hikes, U.S. Recession

The below-consensus Q2 GDP print in the U.S. (0.9% sequential contraction) came on the heels of yesterday’s 75bps rate hike by the U.S. Federal Reserve (Fed) and Chairman Jerome Powell’s hawkish press-conference, at which he mentioned a possibility of another “unusually large” move in September. This is a reminder that the Fed is willing to tolerate a recession in order to bring inflation down. Incidentally, the U.S. is among the countries with the sharpest cuts in the 2022 and 2023 growth forecasts in the just-updated World Economic Outlook (IMF). 

Global Growth Headwinds

The IMF believes that the global balance of risks is squarely to the downside due to a combination of the Russia/Ukraine war’s impact on gas prices, higher inflation and higher costs of disinflation and tighter financial conditions. The new 2022 world GDP forecast is 0.4% lower than April’s projection, and the 2023 forecast was cut by 0.7%. An adverse scenario sees even deeper cuts in global growth projections (see chart below). What was a bit surprising is that the downward revision of the growth forecasts for emerging markets (EM) as a whole was relatively small. In part, this might be due to the fact that parts of EM are expected to benefit from higher commodity prices – these are some Middle Eastern economies and LATAM.

China Growth Slowdown

China, however, is not that lucky. The IMF thinks that the Chinese economy will expand only by 3.3% in real terms this year, which is 1.1% lower than the April estimate. China’s 2023 forecast was cut by 0.5%, to 4.6%. Both numbers are significantly lower than the official growth target of about 5.5%. This is why the market keeps a very close eye on new policy initiatives that could potentially reverse the negative impact of the past – growth-negative – policy initiatives (this sounds like circular reasoning, but…). The central bank’s intention to create a bailout fund (up to CNY1T) to give low-interest loans to real estate developers so that they can complete unfinished apartments (“diffusing” the mortgage payers’ strike in the process) looks promising. But we also learned today that the Politburo was not too keen on aggressive stimulus. Near-term, our focus is on the July batch of China’s activity surveys (out this weekend), which will show whether the economy (especially consumption) enters Q3 in a meaningfully better shape or whether the improvement is still marginal. Stay tuned!

Chart at a Glance: What’s Behind Adverse Growth Scenarios

Chart at a Glance: What’s Behind Adverse Growth Scenarios

Source: International Monetary Fund, World Economic Outlook Update, July 2022

PMI – Purchasing Managers’ Index: economic indicators derived from monthly surveys of private sector companies. A reading above 50 indicates expansion, and a reading below 50 indicates contraction; ISM – Institute for Supply Management PMI: ISM releases an index based on more than 400 purchasing and supply managers surveys; both in the manufacturing and non-manufacturing industries; CPI – Consumer Price Index: an index of the variation in prices paid by typical consumers for retail goods and other items; PPI – Producer Price Index: a family of indexes that measures the average change in selling prices received by domestic producers of goods and services over time; PCE inflation – Personal Consumption Expenditures Price Index: one measure of U.S. inflation, tracking the change in prices of goods and services purchased by consumers throughout the economy; MSCI – Morgan Stanley Capital International: an American provider of equity, fixed income, hedge fund stock market indexes, and equity portfolio analysis tools; VIX – CBOE Volatility Index: an index created by the Chicago Board Options Exchange (CBOE), which shows the market's expectation of 30-day volatility. It is constructed using the implied volatilities on S&P 500 index options.; GBI-EM – JP Morgan’s Government Bond Index – Emerging Markets: comprehensive emerging market debt benchmarks that track local currency bonds issued by Emerging market governments; EMBI – JP Morgan’s Emerging Market Bond Index: JP Morgan's index of dollar-denominated sovereign bonds issued by a selection of emerging market countries; EMBIG - JP Morgan’s Emerging Market Bond Index Global: tracks total returns for traded external debt instruments in emerging markets.

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