Q4 2023 Update from the Asia Trade Floor

What key themes should investors be watching over the next year? What does China’s slowing economy mean for the world? Asia Portfolio Manager Stephen Chang shares insights with Jingjing Huang.

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Text on screen: Jingjing Huang, Credit Product Strategist

Jingjing Huang: Hello, I’m Jingjing Huang, credit product strategist. Welcome to our quarterly Asia trade floor update. Joining me today is portfolio manager Stephen Chang.

Text on screen: Stephen Chang, Portfolio Manager, Asia

Stephen Chang: Thank you for having me, Jingjing.

Jingjing: Stephen, You were recently in London for PIMCO’s September Cyclical Forum. Could you please share with us the key themes that were discussed?

Stephen: Sure. In fact, it was the first PIMCO Forum hosted outside the U.S. – a timely location, given the UK’s economic situation reflects many cross currents happening around the world.

In our view, there are three key themes to watch over the next 6 to 12 months:

Text on screen: PIMCO’s Cyclical Outlook: 3 key themes

  • Growth and inflation have peaked. DM economies face weakness ahead.
  • Recession risks are higher than currently priced.
  • Monetary policy paths are set to diverge.

Firstly, central banks are reaching the end of their tightening cycles, and we believe both growth and inflation have peaked. Among developed market economies, we expect weakness ahead, as fiscal support dries up, and the drag of tighter monetary policy is felt more forcefully.

Secondly, markets currently appear to be priced for an optimistic “soft landing” outcome.

Jingjing: And that seems counter to our outlook.

Stephen: Indeed. We have analyzed 140 tightening cycles across DMs all the way back to the 1960s, and found that,  historically, when central banks hiked by more than 4 per cent, avoiding a recession would be unusual.

The third and final theme, is we believe this collective slowdown may play out differently across countries, depending on their interest rate sensitivity. Structural differences in housing markets and mortgage financing will play a role.

Jingjing: Will China’s slowing economy be a factor as well? Earlier this year, the IMF forecasted that China would drive a third of global economic growth in 2023.

Stephen: The country’s recovery has been weaker than expected, weighed down by the property market. Monthly housing investment, which had been expected to stabilize, is down 11.2 per cent year-over-year as of September.

Our baseline GDP growth forecast for 2023 remains at 5 per cent. Recent activity data has been somewhat better than the beaten down market expectations. Greater fiscal support has boosted infrastructure investment, and monetary easing has helped manufacturing investment, pulling up industrial demand.

However, more stimulus is likely needed to stabilize China's property sector and the economy more broadly. There are risks if the stimulus is insufficient or too slow to arrive.

In our downside scenario, we see growth in 2024 possibly slowing from our baseline of 4.4 per cent to about 3 per cent. This would suppress China’s demand for global goods and services, and weigh on the global economy.

Jingjing: What is PIMCO’s Asia investment team seeing on the ground from China?

Stephen: We think the government still has the capacity and tools to avoid such a downside scenario. More fiscal support, including infrastructure capital spending and tax cuts, could help lift domestic demand.

China’s policy rate is now at 2.5 per cent, and we believe a further reduction is likely. The government has recently called for more counter cyclical macro policies to prevent the economy from a severe deceleration.

Jingjing: With China entering an era of slower growth, along with an aging and shrinking workforce, weak consumer demand, and a property market downturn, there is debate on whether China is facing a “balance sheet recession”, similar to Japan in the early 90s. What is PIMCO’s perspective?

Stephen: We believe there are some similarities, but also two key differences.

Text on screen: China now vs. Japan in early ‘90s

  • China’s corporate deleveraging was engineered by the government, rather than the private sector.
  • China’s household savings rate is above 30% compared to ~15% in Japan.

Firstly, the corporate deleveraging that started in 2014 was engineered by the Chinese government, aimed at reducing risk, whereas Japan’s was driven by the private sector.

Secondly, China’s household balance sheets are well cushioned by high savings – with a savings rate of above 30 per cent vs. around 15 per cent in Japan.

Rebalancing will be key to finding ways to grow household income and thereby consumption.  There is also scope to improve capital efficiency through innovation. Incremental urbanization and Hukou reforms could help mitigate the population-aging problem. Overall, there is potential for improvement in terms of output, consumption and infrastructure per capita.

Jingjing: Given all this, how are we approaching China at the moment?

Stephen: We’re watching for a turning point in the data, before we get more constructive. We have had a more cautious view of China for most of this year, and there has been some disappointment in growth in Q2 and Q3. However, policy makers seem to be willing to adopt more supportive measures, though it may take time to further ramp up and have an effect. We don’t want to jump in too early.

Jingjing: Looking beyond China, in the context of a global portfolio, how should investors position for the year ahead?

Stephen: We believe the outlook for fixed income returns looks good given the high level of starting yields and the risk of recession. Our focus is on the global opportunity set and diversifying our sources of duration. We also want to maintain flexibility and liquidity. Most importantly, position for a broad set of macro and market outcomes, and not just the baseline.

Jingjing: Given today’s heightened economic and market uncertainty, that sounds like a prudent approach. Thank you Stephen for your time today.

Stephen: Thank you for having me.

Jingjing: Good bye.

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