Weekly View - Keeping at it
In his Jackson Hole speech, Fed chair Jerome Powell stood by his hawkish monetary policy stance, despite the below-consensus rises in US consumer prices (core PCE), personal income and spending. The big takeaway from the speech is that the Fed remains vigilant in its efforts to tame inflation, even if this means curbing growth. Perhaps Powell’s main message was to money market traders pricing in rate cuts in 2023. We will be watching US employment numbers out Friday. While equities sold off after the Powell speech, beyond limited tightening at the short end of the yield curve, bonds’ reaction was muted. Meanwhile, President Joe Biden’s student loan forgiveness scheme, which some consider inflationary, could bolster the Fed’s resolve on rates.
In Europe, ECB board member Isabel Schnabel called for forceful action to bring inflation down. A 75 basis-point interest rate rise from the ECB in September cannot be ruled out, although the European economy is already showing signs of weakness. Energy prices continued to skyrocket ahead of a three-day closure of the Nord Stream 1 gas pipeline for ‘maintenance’. We will monitor European inflation figures due later this week. Flash euro-area purchasing manager indices for August showed business activity declining for the second consecutive month, despite the boost to services from summer travel. The euro reached a multi-year low versus the USD last week. In the UK, rising energy bills are hurting consumer finances—perhaps forcing the incoming prime minister to step up support while pressuring the Bank of England (BoE) to tighten, even if the UK enters a recession, as we expect. In September, the BoE will likely announce active selling of its gilt holdings (35% of total gilts outstanding). We expect the UK 10-to-2-year yield curve to invert further if the market expects a severe and protracted recession.
In contrast, deflation potentially looms in China. The Chinese government announced a new package of fiscal stimulus measures last week, including an additional quota of policy bank financing tools (Rmb300 bn), ramped-up local government special bonds issuance (Rmb500 bn) and new bonds to be issued by state-owned power generators (Rmb200 bn). In all, the latest fiscal plans provide additional support to the infrastructure sector, but the magnitude of the measures so far is insufficient to fully offset the slowdown in economic momentum. Our Chinese GDP forecast for 2022 is unchanged at 3.2%. Yet Chinese equities moved up on the week as China and the US reached an agreement on auditing US-listed Chinese companies. This development bodes well for Chinese equities, on which we are neutral. Elsewhere, Japan will restart its nuclear plants.