Fixed Income
Navigating the foggy road to normal
Mike Gitlin
Head of Fixed Income

Rising inflation and slowing growth

Global growth is likely to slow alongside increasing geopolitical risk and uncertainty, tighter monetary policy, and a slowing Chinese economy. There is also a greater risk that inflation will remain higher for longer, given supply chain issues and significantly higher commodity prices. Both these factors could lead to a period of stagflation globally. Over the longer term (10 years and out), the disinflationary forces, such as rising debt levels, technological advancements, and ageing demographics, could start to normalise as supply chains recover and inflation eases.

Projected annual growth rates (%)

For illustrative purposes only
Data as at 9 May 2022. Source: Bloomberg economists consensus estimates

China is not immune to these global forces and is also experiencing a period of slower growth amid an evolving regulatory regime. President Xi Jinping has called for China to achieve “common prosperity” as he looks to balance growth with sustainability and social factors. This is in stark contrast to the previous regime, which focused on achieving growth at all costs. This change in regime will likely result in slower growth in the short term, which poses a significant threat to global markets, given China’s influence on the world economy. In fact, key risk indicators suggest that growth in China could be slower than markets are anticipating. As shown below, the Chinese housing and credit sectors, which have supported Chinese growth over the last decade, have slowed down drastically. China’s zero-COVID policy and continued lockdowns are likely to have a strong impact on growth, and many of these effects could persist for some time.

The Chinese housing market is slowing

Housing sales year-on-year 3-month average (%)

For illustrative purposes only. 
Data as at February 2022. Source: Capital Strategy Research calculations 

Chinese credit growth has weakened

Credit growth year-on-year 12 months ahead (%)

Path to policy normalisation

Policy rates are moving higher, driven by high inflation. Markets expect the federal funds rate to reach around 2.8% by the end of this year with a terminal rate of around 3.0% by the end of next year1. US Federal Reserve (Fed) Chair Jerome Powell believes a soft landing can be engineered, similar to that seen in 1994 when Alan Greenspan raised policy rates from 3% to 6% and achieved the elusive "soft landing" for the economy with inflation contained and continued strong growth. Although this is still possible, the probability of a recession in 2023 is not negligible and is increasing. Asset prices have gone down significantly but so far the Fed has not changed its path to normalisation, and has been willing to let asset prices reset.

Outside of the US, the European Central Bank (ECB) is only at the start of policy renormalisation as it is about 6-12 months behind the Fed and Bank of England (BoE) on policy renormalisation. Whether the ECB will be able to get policy rates to around 1.5% (market expectations) in the next two years is unclear. Markets expect BoE policy rates to reach 2.4% by the end of 2023, which is likely achievable over the next 18 months1. Meanwhile, the Bank of Japan is expected to maintain its ultra-loose monetary policy as inflationary forces remain weak in Japan relative to other major global economies. This divergence of monetary policy between Japan and other economies has contributed to the depreciation of the yen, despite its prior status as a safe-haven asset.

1. As at 18 May 2022. Sources: Capital Group, Bloomberg, Federal Reserve, Morgan Stanley

Mike Gitlin is a partner at Capital Fixed Income Investors, part of Capital Group, with primary responsibility for leading the fixed income business. He is chair of the Fixed Income Management Committee and also serves on the Capital Group Management Committee. He has 26 years of investment industry experience and has been with Capital Group for five years. He holds a bachelor’s degree from Colgate University. Mike is based in Los Angeles.

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