What’s behind the slowdown in China’s economy?
Executive summary:
- Bank of England surprises markets with 50-bps rate hike
- China still looks on track to achieve 5% GDP growth this year
- Equity markets have performed strongly during the first half of 2023
On the latest edition of Market Week in Review, Chief Investment Strategist for North America, Paul Eitelman, and Sophie Antal-Gilbert, Head of AIS Portfolio & Business Consulting, discussed the Bank of England (BoE)’s surprising 50-basis-point (bps) rate hike. They also chatted about the growth slowdown in China and provided an update on the performance of equity markets so far this year.
Inflation concerns spur larger-than-anticipated BoE rate increase
Antal-Gilbert and Eitelman kicked off the conversation by assessing the latest interest-rate increase by the BoE. Eitelman characterized the 50-bps hike, which lifted the central bank’s policy rate to 5%, as a hawkish surprise, noting that consensus expectations were for a 25-bps increase.
“It appears this decision was really driven by the persistently high inflation that the UK continues to grapple with,” he said, explaining that headline inflation in May came in at nearly 9%. In contrast, inflation in the U.S. has been decelerating, Eitelman noted, with headline inflation recently dropping to its lowest level in two years.
He said that by hiking rates further into restrictive territory, there’s a growing sense among Russell Investments strategists that the BoE may have gone too far and overtightened. The central bank’s policy rate could become a serious headwind to economic growth in the UK, Eitelman said—in part due to how the UK’s mortgage market is structured. In the UK, most mortgages are two- or five-year fixed rate mortgages, he said—which is very different than in the U.S., where a 30-year fixed-rate mortgage is the most common type of mortgage.
“This means that when UK interest rates rise substantially, the impacts to borrowers can be significant, as people might have to refinance their homes at a much higher rate. For instance, individuals who refinance in 2024 could see their mortgage payments increase by nearly £3,000,” Eitelman explained. This could obviously dramatically impact household finances, he said, which in turn could elevate recession risks in the UK.
Chinese economic growth fizzles
Switching to China, Eitelman said that after a strong growth impulse in the first quarter of the year, growth in the world’s second-largest economy is starting to fizzle a bit. This lines up with what he and the team of strategists at Russell Investments have been anticipating, he noted.
“We’ve expressed some skepticism around the magnitude of growth China could experience this year, largely because the Chinese government didn’t provide as much fiscal stimulus to households during the pandemic as, say, the U.S. or European countries did. I think that’s one of the reasons China’s growth impulse has weakened recently,” Eitelman said. He added that a fair amount of Chinese stimulus typically comes from local governments selling land. “This simply hasn’t been as big of a tailwind as some anticipated it would be, due in large part to ongoing challenges in China’s property-market sector,” Eitelman remarked.
Ultimately, he anticipates that real GDP (gross domestic product) growth in China this year will come in around 5%—a view unchanged from earlier in the year.
A strong first half of the year for global equities
Antal-Gilbert and Eitelman wrapped up the segment with a look at the year-to-date performance in equity markets, which Eitelman characterized as very strong across the globe. Case-in-point: As of June 22, the benchmark S&P 500® Index is up around 15% on the year, while the MSCI All-Country World Index has risen roughly 12%, he noted.
With that, market leadership in the U.S. has been quite narrow, Eitelman said, explaining that through the end of May, the top seven stocks in the Russell 1000 Index have contributed over 95% of the index’s year-to-date return. “That’s a remarkably high concentration,” he stated, adding that some of the narrow leadership can be attributed to the companies’ links to artificial intelligence (AI) capabilities.
Eitelman said that a shift in investor sentiment has also helped boost market performance this year. “Last year, it seemed like there were a lot of investors who were panicked about the opportunity set in equities due to recession risks. That’s certainly changed a bit in 2023, with market sentiment looking a bit more upbeat,” he noted.
It’s possible that the dip in markets the week of June 19—as of market close June 22, the S&P 500 was down by around 1%, while the MSCI Emerging Markets Index was off around 3%—represents a bit of a deflation in the sentiment balloon, Eitelman said. Ultimately, however, as the halfway mark of the year approaches, there’s no denying that equity markets have performed strongly so far in 2023, he concluded.