The beginnings of a new moderation in bond rally

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  • The Great Moderation was a period of macroeconomic growth and reduced volatility that provided a backdrop to the strong performance of U.S. equities.
  • The lessons hold relevance for equity investors in Asia as big picture conditions for a Great Moderation are starting to fall into place.
  • We believe the “new moderation” mindset will take Asia into its next leg of development, unleashing its potential in a more sustainable and stable manner.

Soo Nam, Head of Asian Equities | June 2, 2014

Lessons from the Great Moderation

One of the great phenomena in the past three decades has been the Great Moderation in the United States. Beginning in the mid-1980s, it was a sustained period of macroeconomic growth and reduced volatility that provided an important backdrop to the strong performance of U.S. equities. Although temporarily disrupted in the 2008/2009 global financial crisis (GFC), the resurgence of “great moderation” dynamics post crisis seemed to have once again helped to support the sustained performance of U.S. equities over the last five years.

The lessons of the Great Moderation hold relevance for equity investors in Asia as we confront a slower pace of economic growth. There are three sets of questions we need to explore. First, are the big picture conditions for a Great Moderation also starting to fall into place? Second, what are the implications for corporate Asia in the current growth slowdown, and the opportunities going forward should it evolve into more moderate yet sustained growth? Third, how should investors position in Asia Pacific ex Japan equities in view of the transformation that is taking shape in the next five to 10 years? These are the questions we will explore in a series starting with the big picture conditions.

According to Ben Bernanke, the Great Moderation in the U.S. was attributable to structural change, improved macroeconomic policies or simply good luck(1). Improved monetary policies have been generally accepted as an important source of the Great Moderation although the GFC was unfortunate and arguably avoidable had policymakers been more vigilant. Nonetheless, the lessons of the GFC help to drive home the point that policymakers need to focus on the sustainability of growth, not just growth per se. A firm commitment to this “sustainability” mindset is important as a starting point for policy-engineered ‘great moderation’ dynamics to kick in.

Current observations in Asia Pacific ex Japan

In Asia Pacific ex Japan, the attention to sustainable policies has been generally adequate in the more developed economies of Hong Kong, Singapore, Australia and perhaps also South Korea and Taiwan. More significant is a noticeable shift in the last few years towards a sustainability mindset in its emerging economies. This shift is continuing to gain traction under the current economic and political climate, particularly in China under the Xi Jinping leadership.

Post the GFC, the Hu-Wen leadership in China rolled out aggressive and hastily implemented fiscal measures in a bid to prevent a sharp slowdown. Low return projects and local government debt issues followed, including the LGFV(2) issues that have been touted as a potential non-performing loan problem for the banks. Policymakers did manage to keep growth above 9% until 2011 (Exhibit 1), but sustainability was quickly called into question. Fortunately, the need to rein in debt was recognized relatively early and significant efforts have been spent in the last three years to keep the situation in check.

Exhibit 1

The shift in policy mindset in China seemed to have accelerated since Xi Jinping and Le Keqiang took the helm, particularly in terms of implementation. Wide-ranging action plans are being rolled out to tackle environmental fallouts and for further reforms towards market-based mechanisms. Monetary and fiscal policy tools are also being enhanced with further interest rate and currency liberalization, and allowing local governments to issue bonds rather than rely on borrowing from the banks via the LGFVs.

China’s current gross domestic product (GDP) growth target of 7.5% is more realistic — this is stabilization rather than a slowdown if we can mentally roll forward the base of comparison to 2012 and 2013. They might have to lower the GDP growth target, but barring unforeseen developments, it should not be significantly down in the next 3-5 years (such as below 6.0%).

There are also encouraging developments elsewhere in Asia Pacific ex Japan. In India, Modi’s election victory on the back of his 14-year scorecard in Gujarat speaks of electorate demands for politicians to deliver sustained growth(3). Indonesia’s opinion polls are predicting a victory for Joko Widodo in the July presidential polls. His popularity stems from a brilliant track record running Surakarta (2005-2012) and Jakarta (since 2012). In the Philippines, President Aquino has set a high bar for his successor as voters go to the polls to choose a new president in 2016(4). Clearly, an increasingly mature electorate has had a positive impact in various emerging Asia countries. As Asia becomes more integrated, the need for nations to compete with their neighbors is also another factor in stirring up a virtuous cycle.

A “New Moderation” runway

Modi’s victory set him up for an initial five-year term and a potential second term. Similarly for Joko Widodo if he wins. The Xi-Li leadership in China will likely be for a 10-year term till around the end of 2022. These three economies are perhaps the most important for sustaining domestic growth within Asia Pacific ex Japan. Good leaders need a good runway to implement good policies. As the era of easy growth winds to an end, the opportunity is for Asia to evolve from a growth slowdown into a sustained period of more moderate yet less volatile growth.

The tea leaves are pointing to the right direction, especially as we start to explore corporate behavioral changes that are concurrently taking shape. This will be the topic of the next installment in this series of discussion where we will start to pin down some firm conclusions for investors.

The “new moderation” mindset taking hold in Asia is translating into more level-headed behavior across-the-board compared to the earlier era of chasing high growth. This will take Asia into its next leg of development whereby its potential will be unleashed in a more sustainable and stable manner. We might well be speaking of a Great Moderation in Asia 10 years from now.


1. “The Great Moderation”, Remarks by Ben S Bernanke at the meetings of the Eastern Economic Association, Washington DC, February 20, 2014.

2. LGFV refers to the ‘Local Government Financing Vehicles’ that local governments created to borrow from banks.

3. Narenda Modi was sworn in as India’s Prime Minister on 26 May 2014. He was Gujarat’s Chief Minister from 2001-20. His party, the BJP, won enough seats in the 2014 general election to govern without the support of other parties.

4. Under the Filipino constitution, a president is not allowed a second term.

Via: columbiamanagement

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