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China and the Fed are partners for now

China and the Fed are partners for now

30-04-2019 | Vision
The data will remain bumpy and markets vulnerable. This is likely to be the case until major risks such as a no-deal Brexit and US-China trade deals are resolved, says Fred Belak, head of Robeco’s Global Fixed Income Macro team.

Speed read

  • Financial conditions have eased globally
  • China remains the father of all global growth cycles
  • US productivity growth bottomed out

“With the bears once again growling, it is time to fade them and use the sharp decline in global bond yields as an opportunity to underweight safe haven sovereign bonds whilst moderately overweighting risk for the next 12 months. By using our macro framework that China drives global growth and the US global liquidity, we view the next quarter as the right time to take a contrarian view as the global slowdown reverses course,” says Belak.

“In our previous quarterly, we stated that this was late cycle, but not end cycle because inflation was not yet elevated. The Fed has now also publicly acknowledged its mistakes at the end of 2018 and turned far more dovish.”

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Figure 1 | The Fed quickly responded to the tightening in financial conditions

Source: Robeco. Goldman Sachs, Bloomberg, Robeco

Introducing a public discussion about their desire to allow actual inflation to temporary overshoot 2% at the top of this cycle to keep inflation expectations anchored, signals a large policy reversal that will extend the current cycle and benefit investors now. Eventually, the bears will be given their due once inflation finally forces the Fed to overtighten and bring on a recession, but that is likely to be a story for 2020.

“At our recent quarterly meeting, one of our guests stated cogently that “China has been the father of every cycle since the Great Financial Crisis (GFC)”. Indeed, 70% of global credit growth since the GFC has come from China. The collateral for this credit growth has largely been the Chinese housing market.” As China comes to the end of 30 years of rapid urbanization, driving housing investment, one of the main risks for the global markets remains a housing bust in China.

The other great recurring concern of the markets is that global debt levels are so high and have only grown since the GFC, so that growth is impaired by the need to service debt. We have sympathy for this argument and indeed see this as an important secular risk.

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