Weekly View - Peak? What peak?
Last Friday showed that US inflation remains stubbornly high. While many had hoped the consumer price index (CPI) figures would show signs of a peak, consumer prices actually rose more than expected, with the year-on-year increase in CPI (8.6%) the highest since December 1981. A 50 bps rise in the fed funds rate at this week’s Federal Open Market Committee meeting seems a done deal as does another in July. But the market is starting to expect the Fed to become more aggressive (some expect a 75 bps rate rise this week and futures markets have been raising their forecast for the year-end fed funds rate). We are not so sure. With tightening financial conditions already impacting the mortgage market and consumer confidence plunging, the Fed must be conscious of the danger of tipping the US into recession. But whether the Fed blinks or whether it strides ahead as it comes under political pressure to deal with inflation, the situation is delicate for assets in general, calling for a cautious, defensive approach to portfolio management.
We will have a slew of data from China this week, with May figures on industrial production, retail sales and fixed investment providing insight into how China is emerging from tight covid lockdowns. Already, last week provided some good news in the form of higher-than-expected export figures. But while we do see re-opening opportunities, we think the jury is still out on China. Chinks of light on international trade (US Treasury secretary Janet Yellen suggested it was time to ‘reconfigure’ Trump-era trade tariffs) could well continue to boost sentiment on Chinese assets. But tensions with the US over Taiwan have been rising again and the property sector remains mired in difficulty. The evidence so far is that the recovery in household spending will be gradual, not least because fiscal stimulus in China has been muted--which in turn reflects a sharp deterioration in government tax receipts. At 4%, our GDP growth forecast for China this year is well below the government’s target of 5.5%.
The European Central Bank’s (ECB) flagging of rate increases starting next month did little for the euro, which slumped against the US dollar last week. This was largely because the ECB did not provide details on how it intended to deal with the risks posed by the rise in bond yields in euro periphery countries, particularly Italy. While the ECB seems unmoved because the rise in spreads over Bunds for shorter-dated Italian debt has been relatively contained for now, movements on two-year paper will be key to watch. We believe the ECB will ultimately come up with an instrument that contains ‘fragmentation’, but before it does so, Italian bonds will be tested. We remain underweight euro periphery bonds.