Market Insights Podcast – 19 September 2022
Year to date, global financial markets suffered the sharpest cross-asset sell-off since 1981, leaving bonds, commodities, equities and other sectors unscathed. The market is beginning to realize that the Fed will continue to tighten the financial environment. The latest U.S. Consumer Price Index (CPI) data showed that inflation is still high, rose 8.3% in August from a year earlier, higher than market expectations of 8.1% while excluding volatile food and energy prices, core CPI rose 6.3% year-on-year in August, higher than market expectations of 6.1%.
The strong performance of natural gas and electricity prices offset the impact of the fall in oil prices. Rent prices remain strong and the rental market seems to show no sign of cooling down. New car prices are still rising. Most core goods and services inflation in the U.S. is driven by wage growth, but what surprising is that rent inflation is also closely related to the month-on-month growth of wages. Rent accounts for 30% in the CPI basket. Therefore, if the imbalance between supply and demand in the U.S. labour market is not solved, core inflation in the U.S. is likely to continue to rise. Even worse is that with much higher mortgage rates, new home buyers are being priced out and therefore will rent, which will continue to pressure rents upward. Even with home prices falling, it doesn’t offset the much higher mortgage rates. Rent inflation will continue.
The recession in the U.S. economy is likely to begin in the fourth quarter of 2022. While the labour market is still one of the few strong sectors of the economy, strong labour demand is a driver of current high inflation. Recent Fed speeches show that members are increasingly worried about the risk of a wage spiral, while the no longer strong number of jobless applicants suggests that the hot labour market is driving the current wage rise. The Fed needs to cool the labour market before expected inflation falls meaningfully towards its target. As a result, continued unusually strong job market data have intensified the pressure on interest rate hikes.
The current weak U.S. retail sales data and a slowdown in the Producer Price Index (PPI) further confirm that the U.S. economy is heading for recession. Logistics giants FedEx Corp. unexpectedly withdrew its guidance for fiscal 2023, which ended in May next year, suggesting that “business conditions have weakened further” during the peak freight season in the fourth quarter of this year, triggering an avalanche of share prices. It is widely believed that FedEx, as a barometer, sounded the alarm of the U.S. economy and was the main driver of its share price falling 21% on Friday. The company’s CEO even warned directly, “We are entering a global recession, and these data do not bode well for the company.”
The global economy may face a recession caused by a wave of aggressive tightening next year, but it may not be enough to curb inflation, the World Bank said in a new report. According to the report’s model, interest rates could be as high as 6% if the central bank wants to keep inflation within its target range. The World Bank study estimates that global Gross domestic product (GDP) growth will slow to 0.5% in 2023, with per capita GDP falling by 0.4%. If so, it would fit the technical definition of a global recession.
International Monetary Fund (IMF) economists Daniel Leigh, Prachi Mishra and Johns Hopkins University economics professor Laurence Ball said in a co-authored paper that in the context of the Fed’s continued interest rate hikes, there is little chance that the U.S. economy will eventually achieve a soft landing. Fed policymakers’ expectations that “inflation will return to the target and the unemployment rate will not exceed 4%” are reasonable only under fairly optimistic assumptions.
The two economists now expect that the unemployment rate in the United States may need to reach 7.5%, twice its current level, to end the high inflation in the United States, which means that about 6 million people will be out of work in the country. According to the fed’s forecast in June, the median unemployment rate will only rise to 4.1% by 2024, when inflation will have returned to about 2% of the fed’s target.
In addition to higher unemployment, the Fed’s continued rate hike will also destabilize emerging market countries. As governments and companies accumulate large amounts of dollar bonds during the outbreak, many emerging markets and developing economies will face difficulties as the dollar rises as interest rates rise.
Powell made another hawkish statement, saying the Fed needs to take decisive and forceful action on inflation. We need to move on until the fight against inflation is done. According to schedule, this is Powell’s last speech before this month’s Fed meeting. The market now expects that the Fed meeting in September is most likely to decide to raise interest rates by 75 basis points for the third time in a row. Analysts pointed out that in the case of economic slowdown, the Fed’s mission and demand on tightening the financial environment has become more urgent, and the so-called “soft landing” to curb inflation without a recession may be fading away.
The White House’s reported plan to refill its strategic oil reserve if crude falls below USD 80 per barrel is providing some support to oil prices. With the U.S. releasing over 180 million barrels into the market, its reserves have fallen to their lowest level since 1984. Under International Energy Agency guidelines, inventories must be at certain levels as a buffer against future disruptions. The prospect of strike action in the U.S. is also providing some support as rail unions threaten to halt train operations, which is a major means of transport for crude and refined products, the bank said. The U.S. Energy Information Administration’s weekly inventory report showed a large build in crude oil, driven by lower exports and weaker demand, and a fall in gasoline stocks.
The aggregate household and corporate deposits held in the banking system in excess of what is normally saved amounts to RMB 34trn or 34% of 2019 GDP since the start of the pandemic – equivalent to the size of the German economy. It is impossible to calculate the effect of the drought on agriculture output and electricity production (hydro-power) but the shock coincides with the economy still decelerating. To date, there is little evidence of the real estate credit issues spilling over into the broader economy. But with producer prices turning over, a deflationary headwind is appearing. The reach for yield never went away.
Last Thursday, the spot exchange rate of the offshore RMB against the dollar fell below the round mark “7” in the foreign exchange market. More than two years later, the exchange rate of RMB against the U.S. dollar has once again entered the “7” era. Deposit rates have been adjusted again, with interest rates on three-year time deposits and large certificates of deposit cut by 15 basis points.
A stronger dollar will tighten financial conditions in the U.S. and around the world, exacerbating the risk of recession. In this context, the RMB may depreciate with the trend. More importantly, it will be more urgent for China to boost domestic demand, especially to relax the negative impact of relevant policies on consumption.
The People’s Bank of China (PBOC) is not too worried about the devaluation of RMB, as long as it does not depreciate too quickly. They expect the RMB to fluctuate below 7 this year. As the U.S. economy shows signs of recession, the market expects that the Fed will stop raising interest rates from the second quarter of next year, and the dollar will no longer be strong by then. PBOC is bullish on the RMB returning to 6.7 by the end of next year, as China has a huge trade surplus, or is popular with investors.
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