Policymakers and central bankers are now compelled to deal with higher-than-expected inflationary pressures, which — if left uncurbed — risk destabilising financial and economic systems and not merely weakening the spending power of consumers.
While the fight to rein in inflation is not new, the rush to cool prices originates from a paradigm shift for central banks, says Selena Ling, chief economist at OCBC Bank.
The market has become so sensitive that hawkish sentiment alone could be more damaging than actual rate hikes.
As such central banks need to manage expectations as well. “What has changed for the central banks is that they are no longer just talking about combating inflation, but they’re talking about the risk of what they call anchoring of inflationary expectations,” says Ling, who is also OCBC’s head of treasury research and strategy.
As central banks impose more significant hikes, the risk of a policy mistake increases correspondingly. “If they front-load aggressively, even when growth is slowing down, the risk is that they drive the economy into an actual recession,” says Ling.
According to the most recent prognosis by the International Monetary Fund (IMF), global GDP growth may slow to 3.2% this year, lower than the 3.6% forecast in April and the 4.4% seen in January.
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“The outlook has darkened significantly since April. The world may soon be teetering on the edge of a global recession, only two years after the last one,” says the IMF’s chief economist Pierre-Olivier Gourinchas.
The IMF made their views just days before the US Federal Reserve (Fed) on July 28 raised Fed fund rates by 75 basis points (bps) for the second straight month to between 2.25% and 2.5%, while signalling that a third hike could be likely in September.
Here, Ling differs from the IMF’s harbingering. “Our baseline [forecast] is that we won’t have a global growth recession this year, but we will see brief and shallow recessions in parts of the world.”
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With US inflation at its highest in four decades, Ling thinks the Fed will likely stay the course. “The Fed is still obsessed with combating inflation and anchoring inflationary expectations. So, barring any quick stabilisation in the inflation readings, it is unlikely that market players may be reading too much into the Fed tea leaves that they are turning more dovish.”
Continuous surprise
The inflation story is not only contained within the US. Singapore — whose trade value is more than three times its GDP — has also been feeling the effects of price increases.
On Aug 11, the government revised its 2022 GDP growth forecast from 3% to 5% to 3% to 4%, citing “deteriorating” external conditions.
Ling alludes to the Monetary Authority of Singapore’s (MAS) Survey of Professional Forecasters from June, which provides a summary of forecasts of Singapore’s key economic indicators by economists and analysts.
Inflation, China and external growth slowdown were the three downside risks that weighed heaviest on experts’ minds. Singapore’s central bank has been quick to respond to inflationary pressures.
Since October 2021, MAS has tightened monetary policy four times, starting with a pre-emptive move when core inflation picked up from 0.7% in 2Q2021 to 1.1% in July to August 2021.
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The latest round of tightening — an off-cycle move by MAS — occurred on July 14.
Ling says MAS “continues to surprise” with their hawkish stance. “I think this second off-cycle move probably will be — and I’ll keep my fingers crossed — the last off-cycle move this year.”
MAS’s managing director Ravi Menon cautions that the full effect of these policy moves to wrestle with inflation will only be felt in the coming 12 months.
He says that exchange rate appreciation “is estimated to dampen core inflation by 0.9% points in 2H2022. The four tightening moves to date are estimated to restrain core inflation by an average of 1.2% points each year.”
However, taming inflation means slower economic growth, warns Menon. He adds: “The outlook for a gentle easing of inflationary pressures globally is also premised on strong monetary policy actions by central banks … A slowdown in economic growth is necessary to restore macroeconomic balance.”
Big-cap shelters
Singapore-listed companies, just like the country’s economy, tend to be significantly exposed to the external environment, be it as buyers or sellers.
As such, high input costs and interest rates could hurt corporate earnings, especially for companies with high borrowings, says OCBC Investment Research head Carmen Lee.
She adds that value or mature companies are less likely to have high debts. “In addition, with risk assets down for the year, this has a flowthrough impact on consumer wealth, and consumers are likely to rein in their spending and demand, which could also impact corporates’ performances and sales.”
Although Singapore is somewhat shielded, it is not entirely independent of these external events, notes Lee. “Risk assets have continued to come under selling pressure, and several markets have seen double-digit declines year-to-date.
Singapore has largely outperformed, which is on the back of several core sectors less impacted by high raw material and input costs.”
While broader market indicators indicate that real estate stocks and REITs are down for the year, big-cap companies in both sectors have done “surprisingly well”, writes Lee.
For example, CapitaLand Investment is up 8.91% for the year, while UOL Group is up 0.7% for the year.
With the current market weakness, the average yield on some of the top REITs has improved to about 5%.
Earnings of the Straits Times Index (STI) stocks will grow at 9.5% this year and 14.1% in 2023. Valuations — at below 10-year historical averages — are not expensive. “Overall, we remain positive on the Singapore market,” says Lee, who has a 12-month target of 3,847 points for the STI.
OCBC’s big-cap picks are Ascendas REIT, CapitaLand Integrated Commercial Trust, DBS Group Holdings, Frasers Centrepoint Trust, Mapletree Industrial Trust, Mapletree Logistics Trust, NetLink NBN Trust, Raffles Medical Group, SATS, SIA Engineering Company, Singapore Telecommunications, ST Engineering, Thai Beverage, United Overseas Bank, UOL Group and Venture Corp.
Still, gold is not favoured by OCBC as it may have run its course with stocks picking up. Ling is “less constructive” on the bullion as an inflation hedge and expects central banks to be hawkish in the short-term. The differential is quite significant for gold, which is a non-yielding asset.
While last year’s earnings have improved enormously from the lows in 2020, going forward into 2023, the strong double-digit growth rates in 2021 are likely to be slashed to single-digit growth, says Lee. “As operating costs go up, this could potentially derail corporate earnings growth.”
Based on the MSCI World Index, the earnings growth rate is now projected at 7% for 2023, compared to a negative 28% growth in 2020 and 84% growth in 2021.
Lee says elevated inflation will mean more short-term market volatility before the situation stabilises. “It is prudent to adopt a more defensive investment stance for now.”
Lee is optimistic that the city-state will be sheltered from the storm and that there are opportunities to stock pick. “While forward expectations for the performances of most markets have been revised recently, the same is not valid in Singapore.
She adds that expectations are holding, capturing a relatively more positive outlook for the Singapore market than the rest of the key markets.
