Insights

The PBoC lowered the 7-day reverse repo rate from 1.80% to 1.70% on Monday. The 5-year and 1-year loan prime rates declined by 10 basis points (bps) to 3.85% and 3.35%, respectively.

However, this 10-bps cut is unlikely to have any meaningful stimulative effect on the overall economy. Not only is the magnitude of the rate cut modest, but it will also merely help lower the debt servicing burden of households and corporations at the margin. Investors should thus not expect any significant demand revival from this new development in the PBoC’s string of muted stimulus efforts.

Our China Investment strategist highlighted in Monday’s BCA Live & Unfiltered meeting that this rate cut was more symbolic in nature and mostly already priced in. Although the challenges facing the economy warrant further rate cuts and stimulus on a 6-to-12 month horizon, the authorities are likely to tread carefully to avoid triggering a rapid yuan devaluation which could trigger panic in financial markets, undermine consumer and business confidence, and delay economic recovery.

All in all, neither the Third Plenum nor the PBoC’s 10-bps rate cut delivered the big-bang stimulus that global investors are hoping for, and there is little scope for further efforts to be sufficiently large to move the needle on China’s growth outlook.

Investors should continue to underweight Chinese equities within a global portfolio.

BCA Research’s Global Investment Strategy service remained tactically bullish on stocks for most of 2023, but shifted to neutral at the start of 2024, and downgraded stocks to underweight in late June. Its latest report fleshes out the team’s thinking in Q&A format.

Our Global Investment colleagues were among the few who argued in 2022 and 2023 that the US would not only avoid a recession but would experience “immaculate disinflation.” Now that this has occurred, why have they turned bearish?

The answer is that they are simply following their kinked Phillips curve framework. The framework says that if an economy is at full employment and inflation expectations remain reasonably well anchored, then falling labor demand will initially lead to lower job openings and slower wage growth. This is exactly what has happened.

Unfortunately, the exact same framework also says that if labor demand continues to weaken, eventually the unemployment rate will surge, culminating in a recession. We will likely reach that point by the end of 2024 or early 2025.

The secular bull market that began in March 2009 is ending. Investors should overweight government bonds and underweight stocks. Within equity portfolios, favor defensive sectors such as consumer staples, utilities, and health care.

The S&P 600 and Russell 2000 have outperformed the S&P 500 by close to 10% since July 9. Small caps typically outperform in the early stages of economic expansions when growth is accelerating, demand-driven inflation is rising and lending standards are easing. Why are they rallying now that economic conditions are at polar opposites?

Small caps are relatively more exposed to domestic economic conditions since their large-cap peers derive a larger share of their revenues from abroad. Periods of US growth leadership are therefore auspicious for small caps’ relative performance. Although the US has been leading global growth for longer than a couple of weeks, the recent broadening of what had previously been an extremely narrow equity rally has lifted small cap indices relative to Mag7 stocks and other non-tech large caps.

Moreover, the soft-landing/no-landing view still dominates markets. Even if one anticipates an upcoming end to the business cycle, our US Investment strategists have shown that the (first and) last deciles of expansions typically post the strongest equity returns. With small-cap valuations more than two standard deviations below their mean, investors may be turning to smaller-sized firms as a means of staying invested at a relative bargain.  

That said, we caution against chasing these gains at such a late stage of the cycle, even though cheap valuations may offer some cushion. Small caps are high beta and our conviction that a recession looms is strong. More attractive entry points await at the other end of the recession tunnel.

Our Global Investment strategists recommend investors who are looking to maintain exposure nevertheless to favor the S&P 600. Its companies score higher on most quality measures and their earnings have grown at a faster rate than their Russell 2000 peers.

UK’s CPI growth stands right on the Bank of England’s (BoE) 2% target. However, services inflation remains sticky, growing at a constant 5.7% y/y in June. Moreover, the deceleration in wage growth remains insufficient to temper inflationary pressures in the services sector.

Our European Investment strategists had previously highlighted that a post-Brexit UK is subject to relatively stronger supply constraints than the rest of the world, while the fiscal response to the pandemic continues to foster an environment of excess demand. Both factors are contributing to sticky wage growth.

Both services inflation and wage growth need to decelerate in order to declare a sustainable return to target inflation. Despite striking a dovish tone at its June policy meeting, the BoE is therefore unlikely to cut rates in August, and likely to lag its G10 peers in easing monetary policy. Interest rate differentials are thus supportive of the pound in the short term.

However, GBP/USD hit a one-year high against the greenback and this cross broke above its key moving averages. Our FX strategists highlighted that net speculative positions are very long the pound relative to the dollar. They would fade any further strength in GBP/USD and recommend selling this cross if the 1.32 threshold is reached.

Total consumer credit rose by USD 11.4 billion in May (to USD 5,065 billion outstanding) from a slightly upwardly revised USD 6.5 billion increase in April, surpassing expectations of a smaller increase. Notably, revolving credit (which includes credit cards) accounted for nearly two-thirds of the rise in May and credit’s advances in May were the highest in three months.

The SIFI banks’ latest round of quarterly earnings calls also underscored that credit card lending continued to grow -- albeit at a modest pace. They reported that their retail customers otherwise evinced little appetite for credit.

A rise in consumer credit is noteworthy in an environment of a softening labor market and dwindling excess savings, given that it may contribute more to consumption growth than we expect. However, we continue to anticipate that a low willingness to lend will cap that contribution.

Lending standards respond to credit performance. Although credit card delinquencies remain low relative to history, they have been steadily rising. The soft-landing/no-landing narrative may still be dominating economic agents’ psyche and this optimism may still support lending. However, compensation growth remains the main driver of spending and credit performance. Lending standards will thus adjust to continued labor market deterioration.

The Q2 editions of the Senior Loan Officer Survey and the New York Fed report on household debt and credit are not yet available, but a sharp rise in transition into serious delinquency (along with weaker demand for loans and tighter bank lending standards across the board) had marked Q1. Given that economic conditions have been relatively stable since then, we do not expect any significant change in credit performance in Q2.