September – A central bank story
The headline was set and the main theme of this monthly letter was pretty much all written and ready for print. And then China acted, and not with superficial measures like last year. This time China took the economic problems (deflation, below target growth, real estate slump, to name the main ones) it is facing very seriously (see below for more).
At about the same time, the Swiss National Bank cut rates by a quarter of a percent, on grounds of inflationary pressure, though inflation is well below target at 1.1%.
And of course, as expected, just a couple of weeks before, the US Federal Reserve also acted in a rather bold manner, slashing the overnight rate by a half percentage point. Although predicted, the Fed had never started cutting rates by this much in a non-emergency situation. The only three times were in 2001 (tech bubble), 2007 (global financial crisis) and 2020 (Covid-19 pandemic).
Finally, a week prior to the US, the European Central Bank also cut the deposit facility rate by a further 25 basis points, the second so far this year.
Data source : Bloomberg
A few elements supported the Fed’s cut by this amplitude. First, job related data somewhat deteriorated. Nothing alarming, the figures remain healthy, but the Fed was very vocal about keeping it that way (saying that “with an appropriate recalibration of our policy stance, strength in the labor market can be maintained in an environment of moderate economic growth”). Second, inflation at 2.5%, while not at the end target of 2%, is below the level that the Fed targeted for 2024 year end, though they were clear that they would monitor the impact of the cuts on the economic activity and resulting inflation before acting further. Core inflation (ex food and energy), at 3.2%, has a harder time coming down. Leading economic indicators such as the Purchasing Managers’ Index (PMI) or the Michigan Consumer Sentiment Survey are rather positive.
The market reaction to the rate cut was rather muted, meaning it was already widely priced and anything short of 50 basis points would have resulted in a correction.
The Euro Area has more reasons to be cutting rates. It suffers from higher unemployment, inflation is now below target at 1.8%, GDP growth barely above sea level and leading indicators are depressed (the PMI is back in contraction territory).
China, which we called “lame duck” just a month ago, took everyone by surprise with a comprehensive package of monetary and fiscal stimulus to boost its’ economy, erasing about a year of bad market performance. Some of the measures include a cut in key policy rate and reserve requirements to increase liquidity in the banking system, a downward adjustment to mortgage rates and a lowered minimum down-payment to support the real estate market. Importantly too, a commitment to add further measures if needed.
Our summary recommendations
As all central banks are lowering rates, this of course has an impact on the yields we see in the bond market.
There are attractive alternatives to plain vanilla high-quality bonds that we have been recommending for the past couple of years. We are looking for example at Collateralized Loan Obligations (CLO), private credit, private infrastructure and structured products that are interesting even in low volatility environments. We will be happy to present each solution in due course.
Chart of the month
The chart below shows the evolution of the Shanghai Stock Exchange (CSI 300 Index) over the past 5 years. You will notice the downward trend since early 2021. Following the announcement of the Politburo, the impact was significant and immediate, rising close to 27% over a day and therefore recovering the losses incurred since mid-2023. The question is whether this is a change in paradigm or a temporary rebound.
Data source: Bloomberg
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