The East and West are swapping monetary policies, get ready

In the coming months a major change will take place in international economic policy. The East will stop its economic tightening and the West will start. Such a change surely marks a highly significant moment for asset allocators.

Over recent weeks, a groundswell of commentators on Citywire has argued not merely that this monetary policy shift is taking place but that it is being accompanied by a concurrent change in the prospects of companies in the West and the East.

Citywire’s Investment Line column has argued since December that 2011 will be a year of two halves, with the current momentum behind developed market shares ending halfway through the year as the US Federal Reserve ends its free sponsorship of a risk rally. In essence we have contended that as the Fed begins to tighten, investors will want to return to the structural growth on offer in the East.

That prediction looks much more certain now than it did in December for two reasons. First, because the evidence arguing for Western rate rises has mounted and second, because evidence has built that China has got on top of its own inflationary problems.

In this week’s issue both independent economist Roger Nightingale and Cazenove UK opportunities manager Julie Dean have highlighted the reasons to believe that Western monetary tightening is coming, and coming at the wrong moment for businesses.

The reasons are in themselves relatively straightforward. Interest rate rises are going to tax margins just as input costs in areas like fuel and food are acting as a tax on profits. This could well mean the bond yield curve – that is effectively now forecasting the economic recovery to continue in a straight line – proves overly optimistic as the developed world’s economic growth is shown to be self-limiting.

Further evidence has come in recent days with news that UK CPI has hit 4.4%, a fraction below the peak the Bank of England forecast for the year just a month before.

Victor Shvets, chief strategist at Samsung Securities, believes the moment is now coming for this realisation to take hold. ‘Evidence is growing that emerging markets are moving toward – or in some cases ahead of – the inflationary curve and starting to contain overheating risks.

‘On the other hand, evidence is accumulating that inflationary pressures are building in developed markets and that central banks are beginning to fall behind the inflationary curve.’

Controversial views