The sustainable investor for a changing world

FRONT OF MIND | Article - 4 Min

Weekly market update – More policy and inflation complexity ahead

Uncertainty over how long it will take to tame inflation has kept the US Federal Reserve (Fed) and European Central Bank (ECB) in policy tightening mode. That could leave equities struggling as markets adjust their views on the likely paths of central bank policy and bond yields move higher in the short term. By contrast, in Asia, the current cycle is more about normalising monetary policy than raising rates to fight inflation. GDP growth and financial markets in the region may thus outperform those in the West.  

Since the Fed started tightening its monetary policy last year, sectors sensitive to interest-rate movements have responded in predictable fashion: Housing starts and sales have fallen on rising mortgage rates, while consumer spending on durable goods and business investment have faltered in the face of higher financing rates.

As the US economy normalised after the Covid shock, consumer demand – especially for services – recovered, pushing up prices, and the post-pandemic catch-up in hiring boosted job gains. Both inflation and labour demand have been sticky.

Persistent hiring resulted in unit labour costs surging by 6.6% year-on-year (YoY) for the full-year 2022 compared to only 2.1% in 2021 (see Exhibit 1), while labour productivity was revised down to -2.0% YoY from -1.5%. It is no surprise then that the Fed worries about inflation expectations becoming unanchored.

Fed Chair Jerome Powell reiterated his hawkish anti-inflation message in his recent congressional speech (7 March), saying that strong demand would likely warrant higher interest rates than previously expected, thus keeping open the possibility that rate increases could speed up again.

Across the Atlantic, the ECB’s policy tightening does not seem to have done much to cool demand or inflation in the eurozone either. Core inflation has remained high and sticky, rising by 5.6% YoY in February from 5.3% in January, even as the headline rate eased to 8.5% from 8.6% in January.

The fact that core inflation is proving stubborn – well above the ECB’s 2% target – both puzzles and worries the ECB. It is puzzling because as the eurozone economy recovers from the worst of last year’s energy crisis, lower oil and gas prices should pass through to core goods and services inflation. Except that it hasn’t. Such persistently high core inflation is also worrisome as it increases the risk of a wage-price spiral given the still-strong eurozone labour market.

Financial markets have thus been repricing to account for a shift in central banks’ policy rate paths. In the US, the fed funds terminal rate is now expected to surpass 5%. The ECB’s peak rate for this cycle is expected to hit 4.0%. And in Japan, the 10-year government bond yield is testing the Bank of Japan’s ‘yield curve control’ upper bound of 0.5%, reflecting market expectations of higher Japanese interest rates.

Inflation complexity

The outlook for inflation remains uncertain for this year and into 2024.

To start with the US, one scenario is that inflation continues to trend down towards the Fed’s 2% target without damaging economic growth. That would require both labour market and wage growth to slow. Recent macroeconomic data points to a moderate probability of perhaps 25% for this outcome.

Another possibility is that inflation remains sticky at around 3-4% in the coming months. This would force the Fed to choose between crushing the economy to force inflation down to its target, or waiting to see if inflation simply eases enough on its own. Mr. Powell’s latest warning suggests that the Fed would sacrifice growth in order to bring inflation down quickly. The probability of this outcome could be as high as 50%.

Lastly, (core) prices may rise again later this year and into 2024, perhaps to 5%, as the combined strength of the US labour market and the re-opened Chinese economy drive up services and goods inflation. This outcome may have a probability of 25%.

Putting these scenarios together gives an expected inflation rate of 3.25-3.75%, which would mean that the Fed and the other major central banks are not yet done with raising interest rates.

Crucially, this is not just about a range of scenarios. It is also about probabilities shifting over a short period.

The resulting uncertainty shows up in the short-term outlook for economic activity, prices and monetary policy. It also applies to long-term shifts in structural dynamics such as the clean energy transition, shifts in global supply chain patterns, and the rise of regionalisation (led by China) clashing with de-globalisation (led by the US).

In the absence of recessionary forces taming inflation, market expectations of Fed policy will continue to drive the outlook. The Fed’s increasingly hawkish views will likely cloud both stock and bond valuations in the short term.

The China factor

Adding to the sea of uncertainty is China’s recovery. Recent data shows there is already good momentum. February’s PMIs were at multi-year highs, city commuter passenger volumes have rebounded to pre-Covid levels, and property market transactions are recovering to pre-Covid levels from a deep contraction.

Some observers may wonder whether China’s recovery will add to global inflation and thus increase the pressure on developed market central banks to raise interest rates.

This does not need to be the case; China’s inflation rate is expected to be far below that of the developed world (see Exhibit 2). However, the China factor looks set to remain a catalyst for volatility in global markets.

What is clear to us is that China’s monetary policy is bucking the rate-rise trend in the West. Beijing’s policy easing is part of coordinated fiscal and regulatory shifts designed to revive GDP growth this year and next.

Asia should benefit from China’s recovery. With inflation much less of a problem in the East than in the West, the stance of the region’s monetary policy is more about normalisation than tightening.


Please note that articles may contain technical language. For this reason, they may not be suitable for readers without professional investment experience. Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice. The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns. Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions). Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

Related insights

12:48 MIN
Talking heads – Banks transition to a new regime
Daniel Morris
2 Authors - FRONT OF MIND
03-29-2023 · 2 Min
Weekly market update – The dust settles slowly

In the U.S., this material is for Institutional use only – not for public distribution. This material is provided for educational purposes only and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be and should not be interpreted as recommendations. Reliance upon information in this material is at the sole risk and discretion of the reader. The material was prepared without regard to specific objectives, financial situation or needs of any investor.

These documents and video clips may also include information obtained from affiliated investment management companies within BNP Paribas Asset Management, the brand name of the BNP Paribas group’s asset management services. The documents and video clips are produced for informational purposes only and do not constitute: 1. an offer to buy nor a solicitation to sell, nor shall they form the basis of or be relied upon in connection with any contract or commitment whatsoever or 2. investment advice. Any opinions included in these documents and video clips constitute the judgment of the author/ presenter at the time specified and may be subject to change without notice.

This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections, forecasts, and estimates of yields or returns. No representation is made that any performance presented will be achieved by any funds, or that every assumption made in achieving, calculating or presenting either the forward-looking information or any historical performance information herein has been considered or stated in preparing this material. Any changes to assumptions that may have been made in preparing this material could have a material impact on the investment returns that are presented herein. Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy.

The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by BNP PARIBAS ASSET MANAGEMENT USA, Inc. to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy.

The information provided here is neither tax nor legal advice. Investors should speak to their tax professional for specific information regarding their tax situation. Investment involves risk including possible loss of principal. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation, and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are often heightened for investments in emerging/developing markets or smaller capital markets.


BNP PARIBAS ASSET MANAGEMENT USA, Inc. is registered with the U.S. Securities and Exchange Commission as an investment adviser under the Investment Advisers Act of 1940, as amended. BNP PARIBAS ASSET MANAGEMENT USA, Inc. is a registered trademark of BNP Paribas or its subsidiaries in the United States and elsewhere. All other trademarks are those of their respective owners. © 2022 BNP PARIBAS ASSET MANAGEMENT USA, Inc., All rights reserved.

BNP PARIBAS ASSET MANAGEMENT is the global brand name of the BNP Paribas group’s asset management services. © 2022 BNP PARIBAS ASSET MANAGEMENT USA, Inc., All rights reserved.

BNP Paribas Asset Management seeks to integrate environmental, social and governance (“ESG”) factors into all of our portfolios as a means to mitigate certain short, medium and long-term financial risks, identify better long-term investments, and encourage more responsible corporate behavior. We will never subordinate our client’s interests to unrelated objectives. Certain issuers and industries are excluded from our actively managed portfolios based upon our view of their ESG performance and risk profile. As a result, we may pass up certain opportunities when these excluded issuers or industries are in favor. Due to significant gaps in disclosure regimes around the world, we may need to rely upon voluntary disclosures by issuers, which are often not audited. We therefore may not have consistent access to complete, accurate or comparable information about the ESG performance of our holdings. Please consult the applicable offering document for more information about the specific ESG strategy employed by each investment strategy since a given strategy may not have specific ESG guidelines, and investments are not limited to securities that are ESG compatible.

To access insights from our teams worldwide visit:
Explore VIEWPOINT today