A step forward in policy fine-tuning

U.S. entering a tightening cycle; volatility remains

Inflation in the U.S. and the pace of Fed’s rate hikes will likely create more volatility heading into 2022. Market expectations on U.S. inflation may shift with spending rotation between goods and services, supply chain disruptions and labor market bottlenecks. Covid waves could pivot those expectations from time to time. Given that inflation is now above the 2% target, coupled with the tight labor market and growth moderating (2021: 5.6% YoY real GDP, 2022E: 3.8%, Bloomberg consensus), we view that we are heading towards a path for policy normalization.

We believe a hawkish Fed tone will remain in 1H22 and market volatility may stay elevated for a sharper normalization path. The market is now pricing in four to five rate hikes by end-2022, with the first one to commence in March along with balance sheet runoff. That said, the market, as always, will react ahead of the Fed and may turn towards a more sanguine policy path as we move through the year. We are mindful of liquidity tightening and growth slowing to coincide in 2H22. As the market runs ahead to price in rate hikes, we expect the 10-year U.S. Treasury yield should march a tad higher from current level (1.9% as we wrote) in 1Q22.

China’s policy fine-tuning to support growth and sentiment

Pandemic restrictions have been taking a toll on China’s activities. 4Q21 saw depressing retail sales and sluggish property sales. Although exports were strong on global demand recovery, domestic infrastructure investment lagged. The National People’s Congress (“NPC”) that will commence in early March may set the “above 5%” growth target and policymakers will step up on easing efforts. These may include front-loaded special local government bond issuance, property easing and monetary relaxation. While China’s GDP growth is likely to slow sequentially in 1Q22 (2021: 8.1% YoY real GDP, 2022E: 5.2%, Bloomberg consensus), we expect it to bounce back in 2H22 on further consumption rebound and pick up in property sales.

We retain our view that credit contraction has bottomed out and credit demand would improve, but with a lag. Nevertheless, this should support sentiment towards China’s credit market. Within the property sector, there were some signs of coordinated policy relaxation, including eased control on mortgage and developers’ financing since late last year. Recently, the potential relaxation in restricted presale funds has also given the sector a relief rally. We expect more property easing to come, but will unlikely to be an aggressive stimulus that we saw in the 2015/16 cycle.

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