It turns out inflation’s not dead

At least in the UK, instead

With prices there surging

The market is purging

All thoughts rate cuts might be ahead

However, elsewhere, there’s concern

That soon there will be a downturn

Thus, stocks have reversed

And possibly burst

The bubble for which most folks yearn

Interestingly, inflation discussions are really beginning to diverge around the world.  What had been a global phenomenon, with prices rising everywhere on the back of pandemic lockdown induced shortages combined with massive fiscal stimulus pumping up demand, is starting to shake out a bit more idiosyncratically.  While in the US we have seen a clear reduction in the trend of prices over the past year, albeit still far above the Fed’s comfort level, elsewhere, this is not necessarily the case.  Today’s example is the UK, where CPI printed at 8.7%, far above the median forecast of 8.2%, although mercifully lower than last month’s 10.1%.  However, core CPI, which excludes energy, food, alcohol and tobacco in the UK, rose to 6.8%, a new high level for this bout of inflation and the highest in the UK since 1992.

One cannot be surprised that the market responded with Gilt yields jumping more than 6bps while the rest of global bond markets have seen yields decline in the face of a broad risk-off sentiment.  More impressively, the OIS market has immediately priced in more than 30bps of additional rate hikes before the end of the year this morning.  While UK stocks are lower, so are equity markets everywhere around the world and perhaps most surprisingly, the pound has only fallen -0.2%.  I suspect that is due to the tension of higher interest rates supporting the currency while worries over the future of policy and the economy are undermining it.  That said, year-to-date, the pound is still the best performing G10 currency vs. the dollar, with gains on the order of 2.5%.  If pressed, I would expect that the pound is likely to range trade going forward as the market continues to reprice Fed expectations higher (removing those forecast rate cuts) while the UK side remains stagnant for now.

Turning our attention to the economy writ large, there is a growing sense that the widely expected recession is coming soon to a screen near you.  Data continues to show weakening trends with, for instance, today’s German IFO Expectations falling to 88.6, far below forecasts, on the back of weakening manufacturing trends in Germany.  As well, yesterday’s US data had its lowlights with the flash manufacturing PMI falling to 48.5, while the Richmond Fed Manufacturing Index fell to -15, both well below expectations.  Layer on the background debt ceiling concerns, where the most recent word is that talks have stalled right now, and there is plenty of reason to turn pessimistic on things.  Arguably, these were keys to yesterday’s equity market declines in the US and we have continued to see red on the screens in every market in Asia and Europe. 

One of the biggest market concerns is China, where talk of slowing growth is continuing as this month’s production and investment data, released last week, was generally softer than expected with property continuing to drag things down, but fixed assets in general softening further.  There continue to be expectations that the PBOC is going to be easing monetary policy further and the renminbi’s recent slide shows no signs of stopping.  This view is also evident in commodity markets, specifically metals markets where copper (-1.5% today, -4.1% in the past week) and aluminum (-0.6%, -3.7%) are under increased pressure as concerns over slowing Chinese growth are impacting demand for these key industrial metals.  

There is, however, one place where this is not so evident, oil prices (+1.5%) as the market continues to respond to prospective production cuts by OPEC+ in the coming months.   The thing about oil is that its demand elasticity is nearly vertical.  Certainly, at the margins there can be more or less demand based on the economic conditions extant, but there is a baseline of demand that is simply not going to disappear.  It is important to remember that despite all the efforts at reduction in the use of fossil fuels, global oil demand hit a record last year.  It is also key to remember that for the past decade, investment in the production of new oil and gas reserves has been severely lacking.  The implication is that while oil prices have fallen well below the highs seen in the immediate wake of the Russian invasion of Ukraine, nothing has changed the long-term supply demand equation which greatly favors demand over supply, i.e. oil prices are likely to rise consistently, if not steadily, over the coming decades.

Summing it all up, today appears to have investors and traders thinking the worst, not the best of things going forward.

A quick look at overnight markets shows that equity market declines have largely been greater than -1.0% with the biggest markets, DAX, CAC, FTSE 100, pushing -2.0%.  There has been no place to hide here, and from a technical perspective, yesterday’s price action looks like an outside bearish reversal, which simply means that the closing level has market technicians selling for right now.  We have seen a significant equity rally in the face of a lot of negative news, so perhaps that run is now over.

Global bond yields are consolidating recent gains, with small declines today not nearly enough to offset what had been 30bp-40bp increases in the past two weeks.  In this market, clearly the debt ceiling talks are the primary story with macroeconomics a distant second for now.  There is just one week before the X-date, at least the latest one, and I suspect that we will hear of an agreement early next week helping to reduce at least some of the pressure on risk attitudes.

Lastly, the dollar is largely stronger this morning with an outlier in NZD (-1.85%) which fell sharply after the RBNZ essentially promised that last night’s 25bp rate hike, to 5.50%, is the last one coming, a big change from market expectations of a 50% probability of a 50bp hike last night.  Essentially, they explained that property market pressures and slowing consumer activity convinced them rates are appropriate to fight inflation.  Kiwi dragged Aussie (-0.5%) lower as well, but the rest of the bloc has seen far less damage with the yen (+0.15%) actually managing a small gain.  But make no mistake, over the past week and month, the dollar has regained its footing, at least against the G10.

In the emerging market bloc, the picture is more mixed with both winners and losers overnight with HUF (+0.8%) the leader, bouncing after the central bank cut its Deposit rate by 1 full percentage point yesterday, as expected and the forint fell sharply.  Meanwhile, MXN (+0.6%) is also showing signs of life after having fallen every day in the past week as the market now assumes Banxico has finished its rate hikes.  On the downside, MYR (-0.45%) and KRW (-0.4%) are both feeling the pressure of the weaker Chinese growth story given its importance to their own economies.

On the data front, the FOMC Minutes are released this afternoon and have a chance to be quite interesting given what appears to be the beginning of a split of opinions regarding the appropriate next steps.  As well, we hear from Governor Waller around lunch time, and ahead of the Minutes.  Waller certainly leans toward the hawkish end of the spectrum, so keep that in mind.

Adding it all up and the combination of declining risk appetite and a growing belief that the Fed is not going to pivot anytime soon implies that the dollar should maintain its footing for now.

Good luck

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