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Joe Little

Renee Chen

As economic growth restores itself in the aftermath of Covid-19, rising inflation and the timing of US Federal Reserve tightening is back on investors’ minds. Fed officials continue to talk a dovish game, but investors have doubts, especially given sharply rising consumer prices and elevated asset valuations.
After US inflation rose to a 13-year high in April, the Fed reassured investors that the surge was transitory and that policy lift-off would be deferred until maximum employment is reached. But investors’ doubts have intensified against a backdrop of higher bond yields, the Biden infrastructure plan, and some economists predicting a cyclical overheating.
In assessing the inflation and policy outlook for the United States and other Western economies, one important clue could be the recent trends in Asia.
After all, China and the industrial Asian economies have been the lead indicators right through the pandemic – as the first into it and the first to return to pre-pandemic gross domestic product levels. There are three important Asian policy trends.
First, a rapid pickup in inflation is not enough to unsettle policymakers. Consumer price indices (CPIs) are rising quickly in South Korea, Singapore and Taiwan compared to the low base last year, driven by higher energy costs and the demand recovery. In China, producer and wholesale price inflation is also rising quickly, and concerns around price stability and affordability have been noted.


Across the region, supply constraints on semiconductors and other inputs mean that some sectors face cost pressures and profit margin squeezes. Yet so far, Asian central bankers appear relaxed, willing to look past supply-side inflation or to deal with it using regulatory measures.
Second, Asian central bankers remain focused on medium-term inflation drivers. The dominant framework across industrial Asia is the “expectations-augmented Phillips Curve”, which emphasises labour market slack and inflation expectations as inflation forecasters.
In Singapore, for example, the monetary authority concludes that economic slack means core inflation will be 0-1 per cent this year. And, in South Korea and Taiwan, it helps us understand why officials are closely monitoring the recent rise in inflation expectations.
Third, Asian policymakers are not in the business of popping asset price bubbles. Most industrial Asian central banks have either a financial stability mandate (South Korea, Singapore, Taiwan) or a housing affordability objective (China, South Korea, New Zealand). Therefore, the main policy concern is typically systemic leverage or house price bubbles.
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Exuberance in stock markets is a second-order problem. The rapid rise in New Zealand house prices is a good recent example of what concerns policymakers. And, as we are seeing, such excesses tend to be tackled with macroprudential measures rather than pre-emptive interest rate hikes.
What does all this mean for Asian monetary policy? And what is the read-across for Western investors?
Despite Asia’s quick macroeconomic and financial market recovery, we see a dovish and patient policy response. In China, a well-telegraphed policy normalisation is under way. For the Asian tigers, the likelihood is for policy adjustments for South Korea, Singapore and Taiwan only sometime in the first half of next year.

At the dovish end of the spectrum is Australia, where a focus on achieving maximum employment commits the central bank to keeping rates down until 2024 at least.
In the US, GDP only returned to near pre-pandemic levels in the first quarter of this year while Europe has yet to do so. If the Fed follows the Asian playbook﻿, policy lift-off could come as early as the end of next year. But, given that the Fed’s new “average inflation target” tolerates some overshooting, much later policy lift-off is more likely, in the first or even second quarter of 2024.
Clearly, the policy outlook remains dependent on inflation. Like Asian policymakers, the Fed will look at labour market slack and inflation expectations. Investors should prepare for US inflation to be much closer to – or slightly ahead of – the 2 per cent goal over the medium term.
But, more than anything, we should prepare to be surprised. And don’t forget to track developments in China and industrial Asia.
Joe Little is global chief strategist, and Renee Chen is senior economist and investment strategist, at HSBC Asset Management


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Opinion

Business


Central banks in China and the industrial Asian economies leading the economic recovery have been dovish and patient, unfazed by the recent pickup in inflation
Similarly, the Fed is unlikely to tighten policy this year and could even leave it until 2024



Asian central banks have been dovish and patient, unfazed by the recent inflation pickup as their economies recover. The Fed is likely to do the same.


US Federal Reserve

Central banks

China inflation

Singapore

Taiwan

South Korea

Bonds

Interest rates

China economy

China GDP

Expresses the views, ideas and conclusions of the author. (Eg. Enough of Crazy Rich Asians, think of crazy poor Hongkongers.)


Column

Eye on Asia