China tweaks its zero-COVID policy. Could more changes be in store for next year?

by Alex Cousley, Russell Investments

On the latest edition of Market Week in Review, Investment Strategist Alex Cousley and Sophie Antal-Gilbert, Head of AIS Portfolio & Business Consulting, discussed recent developments in China, the outlook for U.S. Federal Reserve (Fed) rate hikes and the new UK budget.

China eases some COVID restrictions

Antal-Gilbert kicked off the conversation by noting that China recently took some small steps in loosening its zero-COVID policy, including reducing the length of time visitors must quarantine by two days. Cousley emphasized that the changes are small in scope, and that the nation’s stringent COVID restrictions are unlikely to go away anytime soon. However, in his opinion, it’s possible that the zero-COVID policy could potentially be rolled back sometime during the second quarter of 2023.

“By that point in time, winter will have ended in China, and hopefully the country’s COVID-19 vaccine booster campaign will be far along as well,” Cousley stated. He noted that on the same day the Chinese government made alterations to its zero-COVID policy, it also announced a 16-point plan to shore up its embattled property market, where home prices continue to fall and consumer confidence around home-buying remains weak.

“There isn’t too much detail in this plan, but it does reinforce the idea that local governments should continue encouraging more home ownership by reducing mortgage rates and providing other incentives to buy. Local governments have been doing this for a while, however, and it hasn’t been all that effective yet,” Cousley stated. He said that the 16-point plan also didn’t really address funding needs, but noted that more concrete details around this issue could be released at the next Politburo meeting in December.

Is a slowdown in the pace of Fed rate hikes coming?

Switching to the Fed, Cousley noted that in the wake of October’s U.S. consumer price index (CPI) report—which showed an easing in inflationary pressures—several central bank officials have pushed back on the idea of a potential Fed pivot. “This includes both Fed Governor Christopher Waller and Fed Vice Chair Lael Brainard, who each noted that they still see the federal funds rate moving higher,” he stated. However, both Waller and Brainard indicated that the pace of rate hikes may slow moving forward, Cousley added.

In his opinion, the Fed is probably leaning toward a 50-basis-point (bps) rate hike at its upcoming December meeting, versus the 75-bps increase it’s opted for at each of its last four meetings. The latest market pricing reflects this as well, Cousley added, noting that a 50-bps increase next month would take the federal funds rate to a range of 4.25%-4.50%. “I believe that borrowing costs will probably peak somewhere in the 4.5%-5.0% range, so if there’s a 50-bps increase in December, that could be followed by one or two 25-bps increases in early 2023,” he stated.

Sharp tax increases, deep spending cuts comprise new UK budget

Antal-Gilbert and Cousley wrapped up the segment with a look at the new UK budget unveiled by Finance Minister Jeremy Hunt on Nov. 17. Cousley noted that there was heightened interest around the autumn budget statement due to the debacle caused by former Prime Minister Liz Truss’ plan for unfunded tax cuts. In particular, markets were honing in on expected austerity measures, including tax increases and spending cuts, he said.

The new budget contains roughly £55 billion in sharp tax rises and substantial spending reductions, Cousley noted. Importantly, however, most of the spending cuts won’t occur until 2025, he said. “This essentially kicks the austerity can down the road a bit—as there will still be a balanced budget, but it won’t occur until further out in time than many observers thought,” he said.

Make no mistake, though: the economic forecasts for the UK are very bleak, Cousley said, noting that the UK government and Bank of England (BoE) expect the country to be mired in a recession through 2024. A two-year recession would be the UK’s longest on record, he remarked, noting that the situation appears all the more challenging since the BoE plans to keep raising rates heading into the recession.

Cousley stated that one potential piece of good news is that the budget does contain caps on energy prices. He said that should alleviate some of the near-term pressures around inflation, which soared to 11.1% in the UK during October. However, with inflation at such high levels, even a small alleviation doesn’t mean much, Cousley noted.

“Ultimately, the bottom line in all of this is that while Hunt’s budget contains fewer austerity measures than expected, the UK economy is still in a very tough spot right now,” he concluded.

Editor’s note: Due to the U.S. Thanksgiving holiday, there will be no Market Week in Review on Friday, Nov. 25. We look forward to sharing our weekly insights with you again on Friday, Dec. 2.