There is a lot to discuss when it comes to the overall global front. How do you believe investors should be digesting US inflation which has risen quite moderately in July?
Adrian Mowat: This question relates to what is the Fed going to do in the September meeting and so the ongoing moderation in inflation continues, which is good news. We have to remember that it is above the 2% target. We had what was perceived to be a weak employment print, which has got a lot of discussion going about a 50 basis point cut in the September meeting. I think that it is very balanced between the Fed moving 25 basis points versus 50 basis points. Also, we do have some more labour-market data coming out. So the market will probably be very sensitive to that. But let us understand where we are here.
With the Fed moving policy rates slowly back to neutral, it arguably gives a weakening dollar. For emerging markets to have a combination of an end of a strong dollar and the Fed beginning to move to a more neutral policy takes away some significant headwinds, perhaps even giving some tailwinds.
I am more concerned about the data coming out of China. That has a linkage to India flows as well. Manufacturing has slumped to a six-month low. China’s not out of the woods yet?
Adrian Mowat: We have got a structural problem in China. There are significant issues in the real estate market, both commercial and residential. Property sales were down dramatically year over year again. There are some meaningful deflationary forces at work as asset prices fall and the impact of having leverage hits the ability of corporations and individuals to consume.
I think that is just your investment backdrop. We are not going to escape that structural issue. Now, you can become very bearish talking about that, but it is very important to remember that Japan, which was the second-largest economy for a long period, went through two decades of deflation within Asia. That did not stop the rise of China or India. So, I am not too worried about the external impact of what is going on in China.
The official manufacturing numbers, which are heavily influenced by heavy industry, were very poor. The Caixin PMI, which has just come out, was better than expected and that might reflect the fact that exports out of China have been relatively strong. So, do not read too much into what is going on in the Chinese economy in terms of your willingness to buy a market like India. I do not think that is a significant impact on the Indian economy or even to some extent the regional economies, with one major exception, which will be Australia, where we have seen a significant decline in commodity prices, which hits the Australian current account.So, what is next? What is next for the markets now, could it be the US election? Could it be the Fed? What is next for the markets from here?
Adrian Mowat: The markets will be very focused on the US economic data. If you think about what are the various paths that we could take from here, it might be that the employment data comes out and it proves to be a bit more robust than the market expects and then some of the rate cut expectations will be moderated. As a base case. US rates could easily move from 5.5% down to 4.5%, perhaps hitting a neutral rate of around 3.5% at some point in the middle of next year. That would be a very bullish scenario. If the employment data is stronger than expected, then you are not going to get a 50 basis point rate cut and we are probably not going to move below 5% this year on Fed funds rates.
Now, you can take the other extreme, which is that the US employment numbers are losing momentum and the Fed is deemed to be behind the curve and needs to cut rates more aggressively to get to neutral or even below neutral, and perhaps you get 300 basis points of cuts over the next 12 months. That is a negative message for the US equity market in terms of people being concerned about profits. It will be a negative message for countries like Mexico that sell a lot to the United States.
But it may be okay for other emerging markets in that they get the very important tailwind of a significant reduction in interest rates and after a significant period of underperformance for broad emerging markets, India has been a great performer. There is a chance that emerging markets begin to outperform developed markets because of this new environment, which is the end of a strong dollar and the Fed cutting rates.
