A trader works on the floor of the New York Stock Exchange in New York on October 7. Hopes for a rally in stocks after a difficult September faded after hawkish rhetoric from the US Federal Reserve quashed hopes of an end to interest rate increases. Photo: Reuters
by Sylvia Sheng
by Sylvia Sheng

Higher interest rates are still likely despite weak demand and weak growth prospects

  • The commitment of policymakers at major central banks to reducing inflation even if it drags down growth suggests another lacklustre year ahead
  • Cooling consumer demand and business investment are also fuelling a weaker growth outlook, but a pivot to looser monetary policy looks unlikely
Global equity markets have been nothing if not volatile in recent months. September lived up to its reputation of being a bad month for equity market returns historically. The S&P 500 index slumped 9.3 per cent in September, the worst monthly return since the Covid-19 pandemic hit the United States in March 2020.
October kicked off with a significant rally in stocks fuelled by speculation that central banks could soon ease up on their interest rate increases. However, that enthusiasm quickly reversed as hopes for a dovish policy pivot faded amid hawkish rhetoric from US Federal Reserve officials.
Global equities are likely to continue to face headwinds. The trade-off between growth and inflation in the global economy has deteriorated sharply in 2022. Central banks are tightening monetary policy aggressively to contain inflation.

Meanwhile, growth has already slowed under pressure from various shocks such as high energy prices. As projections from the September Federal Open Market Committee meeting make clear, interest rates will remain elevated throughout next year and policymakers are fully committed to reducing inflation even if it takes a toll on growth.

As a result, the global economy is expected to experience an extended period of sluggish growth that lasts through 2023. There is a substantial risk that the global economy slides into recession.
While the US and some other major economies might be able to avoid full-blown economic recessions, they will inevitably experience sharp downturns. Given that more listed companies are on the goods side of the economy, a recession in the goods sector is not a great backdrop for stocks.
During the pandemic, as opportunities to purchase services were cut off and households in many countries received large-scale income support, the goods sector benefited from a dramatic shift in spending patterns and soaring demand for consumer goods. It received additional support from an unusually quick rebound in business investment spending.
However, both goods demand and production have moderated recently. This could soon lead to further softening and a strong likelihood of outright contraction in the global goods economy.

Consumer spending on goods has stagnated through most of 2022. The transition back towards services spending appears to be in its early days. For example, the goods share of US household consumption is still elevated, and there is ample room for further correction.

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Expect a cooling in business investment spending, too. Surveys of intentions for capital expenditures have faded recently, pointing to more cautious business sentiment. At the same time, the global manufacturing purchasing managers index has slipped, signalling that industrial output could start contracting before year-end.
Emerging Asia faces the greatest risks associated with the goods slowdown. External demand, which is a key driver of the region’s post-pandemic recovery, is showing signs of broad-based weakness.
The slowdown in global goods demand and the shift in developed market consumer spending towards services are weighing on emerging Asia’s exports. Export growth in some North Asia bellwethers has deteriorated sharply in recent months. Exports from both South Korea and Taiwan surprised on the downside in September, with Taiwan recording the first year-on-year decline since June 2020.
The pandemic-fuelled boost to goods demand, especially tech demand, seems to be fading. Tech demand is especially important for emerging Asia given that electronics account for around a third of Asia’s exports. In addition, semiconductors represent large portions of tech exports in both South Korea and Taiwan, suggesting an outsize impact of the semiconductor cycle downturn on their overall exports.


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Moreover, the softening global capital expenditure cycle is weighing on emerging Asia’s capital goods exports such as machinery. The global goods slowdown is especially challenging for small, open economies such as South Korea and Taiwan, which are more exposed to external demand.

Even with a weaker growth outlook, a swift loosening of monetary policy appears unlikely. As inflation is sticky in most regions, major central banks have more work to do.

Fed officials said last week that they needed to see evidence that underlying inflation had solidly peaked before considering a pause in raising interest rates. While goods price inflation has begun slowing at the margins, core inflation is expected to remain above central bank targets next year as services inflation persists at high levels.

The risks are tilted towards inflation remaining high. Labour markets might prove resilient to a spell of soft but not negative economic growth, keeping wage inflation elevated. At the same time, inflation expectations might have drifted high enough to hold inflation steadily above central bank targets.

Sylvia Sheng is a global multi-asset strategist at JP Morgan Asset Management