Climbing the wall of worry

“It’s not enough” said the market

The evolving situation in China remained in the spotlight for investors this week. Since policymakers launched their ‘big bazooka’ two weeks ago aimed at boosting domestic demand, Chinese stock markets have experienced a roller coaster ride.

Optimism has quickly turned to disappointment after announced measures failed to provide significant details on the size of fiscal stimulus needed to offset structural problems. Namely, investors await key details on how authorities plan to absorb the overhang of unsold properties and how much money will actually be injected into the economy.

Like Japan in the 1990s, Beijing is wary of falling into a deflationary cycle. But concerns around public sector indebtedness limit how much support they can realistically lend. In addition to these structural challenges, cyclical risks to growth loom in the near-term.

Export growth was a major boon for the Chinese economy this year, but is expected to slow given the slump in global manufacturing and concerns about trade tariffs. Taken together, market uncertainty is likely to remain elevated.

US cruising ahead (again)

The US economy continues to have a penchant for defying the pessimism that has plagued investor sentiment since the pandemic. After a growth scare in the summer, Thursday's retail sales report showed that the good times aren't over.

A similar message was echoed in the various spate of earnings released from America’s largest banks this week, which viewed spending patterns as solid and consistent with a growing economy.

More importantly, how will the Federal Reserve interpret this? Their reaction function remains asymmetrically biased towards supporting the economy given fears of a non-linear deterioration in the labour market. Spending habits are closely tied to the jobs market, which has been arguably softening lately. This raises questions about the sustainability of strong consumption growth.

Markets have pared back bets on interest rate cuts since economic data has improved, but the modal view remains that rates will continue to be lowered all the way down to around 3.3% by the middle of next year. A scenario where growth holds up and policy is being eased does suggest a relatively bright outlook for risk assets.

More cuts please?

The ECB delivered another 25 basis point cut at its policy meeting, citing progress on inflation and unexpected weakness in Eurozone growth. But the risks are clearly skewed towards a faster or deeper cutting cycle given the anaemic recovery.

The case for more aggressive easing also increased in the UK, where inflation slipped below 2% for the first time since 2020 and pay growth dropped more than expected. Markets responded by selling the pound and increasing wagers on interest rate cuts.